It's easy to see the allure of dividend stocks. They're great at supplementing one's fixed income, and they can be a powerful vehicle to build wealth over the long term. But for it be an effective investing strategy, investors need to buy great companies that have the ability to keep paying those dividends for several years into the future -- and increase them, too.
With that in mind, three companies that look to have the traits you want in a dividend stock today are Holly Energy Partners (HEP 1.03%), 8point3 Energy Partners (CAFD), and W.W. Grainger (GWW 1.03%). Here's a quick look at what makes these companies attractive and why I'd be comfortable buying them now.
An energy stock without its industry's biggest risks
Holly Energy Partners has been a quiet stock that consistently gets overlooked by the market, as evidenced by its current distribution yield of 7.7%. Sure, it's a master limited partnership in the energy industry, and being one has produced great stock returns over the past couple of years. That being said, the company isn't set up in a way that many of its peers are, and that suggests that it is well suited as a long-term dividend investment.
A major uncertainty for anyone in the oil and gas industry is commodity risk -- whether it's exposure to the rise and fall of commodity prices or the chance that rising and falling production volumes will impact revenue streams. Holly Energy Partners doesn't have to worry about them nearly as much as others for two reasons. First, 100% of its revenue is based on fee-based contracts that have no commodity exposure. Second, much of its assets are contracted to serve its parent company, HollyFrontier (HFC), with minimum volume commitments for pipelines and storage or long-term tolling agreements for processing services.
These help to reduce commodity risk significantly and provide a stable, relatively predictable cash stream it can use to consistently reward shareholders. In fact, just this last quarter, Holly Energy Partners announced its 48th consecutive quarterly distribution raise while maintaining a decent cash cushion that will permit for that streak to continue for some time. If investors are looking for a high-yield income investment with a reasonable amount of stability, then Holly Energy Partners is a great place to start.
A sturdy ship in a stormy market
One of the biggest challenges of investing in the solar industry is that while the opportunities for growth are staggering, the business of building solar panels and developing solar projects is a cutthroat business with low margins and an intense need to spend on research and development to improve efficiency. Because of that, many of the companies in this business have struggled to generate consistent profits.
One company that has the potential to be the antithesis of the solar industry is 8point3 Energy Partners. Rather than trying to develop solar projects, its business model consists of buying completed projects that already have long-term sales contracts in place and reap the benefits of long-term ownership. While the company is still pretty young -- it only IPO'd last year -- the company has a strong portfolio of assets with contracts in place that will last 20 years or more and should provide a steady stream of cash. It also helps that, as a subsidiary of both SunPower (SPWR 7.88%) and First Solar (FSLR 2.23%), there is much less risk that one company will sell assets at inflated prices like we saw with similar solar project owners this year.
For a company with a relatively stable cash flow, 8point3 still has a modest balance sheet that should be very manageable. If the company can continue on its pace of relatively modest growth while maintaining financial discipline, then 8point3 Energy Partners could be that one solar stock a dividend investor can get behind.
The dependability of a Dividend Aristocrat with growth levers to pull
While there is no guarantee that a company will continue to pay a growing dividend for as long as you intend to hold a stock, knowing that it has reached Dividend Aristocrat status can give an extra level of confidence that it will likely continue its dividend streak. In exchange, though, that means you are investing in a company that is in a very mature business with only modest growth levers to pull. In the case of W.W. Grainger, you get a company that has a little bit of both.
For decades, Grainger has specialized in supplying medium- to large-sized businesses with all the little things that make the procurement process easier by supplying a wide range of products ranging from janitorial supplies to power tools to transmissions. Much of the company's advantage came down to close relationships with large businesses, but that model doesn't work as well with smaller and medium-sized businesses, so it is now building multiple channel methods to serve customers such as online ordering. So far, it has succeeded as its single-channel business segment -- the one tailored for smaller businesses grew revenue by an estimated 30%-35% in 2016 while generating a staggering return on capital of 50%.
Combine the stable cash flow generation of serving its large customer base with the growth of its new sales channels and expansion into international markets and you have a stable dividend payer with a whole lot of upside. There's not much more you can ask for in a dividend stock.