Source: Flickr user zack Mccarthy.
"The thing is, if you're just oogling fat current dividend yields, you are missing the more profitable boat. When it comes to dividend investing, the far smarter play is to zero in on companies that consistently increase their dividend payouts." -- Wealthifi
All too often, investors go about picking dividend stocks the wrong way. They look at the dividend yield and become mesmerized by that yield. A 7% yield will, for example, according to the simple math of the Rule of 72, double an investor's money in a little over a decade, even if the stock does nothing and the dividend never moves higher. The problem with that is that high yields can sometimes be a warning sign that dividend sustainability is a problem. This is why investors should instead look past a stock's current yield and look for the two key characteristics I've outlined below, as these will yield far better dividend stocks over the long term than simply choosing a stock based on its yield alone.
History matters
A company with a history of raising its dividend is by far the No. 1 consideration an investor should look for when searching for a great dividend paying stock. Take a look at the stock price chart of Energy Transfer Partners (ETP), which is a high-yielding master limited partnership.
For several years, its payout to investors was stuck in neutral. That created a lot of volatility in the share unit price, which could have had a big impact on returns depending on where investors bought units. However, once the company starting increasing its payout, the unit prices started rising nearly in lockstep.
It's a roller coaster ride that could have been avoided by instead investing in a company that was already steadily increasing its payout to investors. Take a look at the difference in the stock chart from Enterprise Products Partners (EPD -0.28%), which has raised its payout for 40 straight quarters.
It's a trend that can also be seen in EOG Resources (EOG 0.88%), which has now raised its payout 16 times in 15 years by a compound annual rate of 23%. As its chart shows, the stock price moves higher along with the dividend.
I could go on, but the bottom line here is that a stock's dividend history matters. It suggests the company's foundation is built up the assets and the management team to keep its dividend moving higher. Now, let's take a look at how to find a dividend that will continue moving higher.
Visible organic growth
A lot of companies call themselves a growth company, because growth sells. However, finding a great dividend growth stock requires an investor to look past the rhetoric and find the proof. We're looking for visible organic growth. If it's a manufacturing company, we want to see it operating at capacity as well as plans to build additional capacity. For an energy company, we want to see a growing inventory of drilling prospects or future pipeline projects that will drive revenue and profit growth. No matter the industry, we want to see visible proof that future growth is more than just management telling investors what they want to hear.
For example, EOG Resources has added five new oil plays to its portfolio of drilling projects in the past year alone. Because of this, its drilling inventory has expanded from 12 years to 15 years in just the past year. This is visible, organic growth that will drive cash-flow generation to keep its dividend heading higher in the years ahead. Likewise, Enterprise Products Partners will be spending $12 billion through 2016 on growth capital projects, which will support a higher distribution in the future. Further, as the following slide points out, the company sees additional opportunities beyond its current spending plans because of the growing North American energy market.
Source: Enterprise Products Partners Investor Presentation.
Investor takeaway
Too many investors are mesmerized by a stock's dividend yield. This causes them to miss out on stocks that will become great dividend stocks in the years ahead. Instead, investors should look for a stock with a solid foundation of historical dividend growth as well as visible organic growth to keep it growing.
