According to Finviz.com, there are currently more than 3,500 publicly traded stocks that pay a dividend. That's an overwhelming number and can make it difficult for a new investor to get started.
To help you narrow down your selection of dividend-paying stocks, we asked a team of Fools to each pick a stock they think is a great choice for a beginning investor who wants to focus on income. They choose Waste Management (NYSE:WM), Microsoft (NASDAQ:MSFT), American Express (NYSE:AXP), Cisco Systems (NASDAQ:CSCO), and Costco (NASDAQ:COST). Read on to find out why.
The benefits of buying disruption-proof businesses
Tyler Crowe (Waste Management): One of the things beginning investors should learn when making their first dividend investment is how to identify companies in essential functions of our everyday lives with nearly insurmountable competitive advantages over their competition. These are the kinds of companies that will have the pricing power to grow revenue and profits for decades to come, and return considerable value to shareholders.
One company that fits this mold incredibly well is refuse handler Waste Management. The company is the largest refuse collection company, and it has a large network of landfills, disposal centers, and recycling facilities across the U.S. The waste-handling business inherently has lots of competitive advantages for its well-established players. It's extremely capital-intensive to build out a fleet of waste collection vehicles, there are lots of regulatory hurdles involved in opening new landfills and maintaining existing ones, and it's extremely difficult to disrupt how humans generate and handle waste. These things combine to give Waste Management a very favorable operating environment where it can pass along rising costs to customers pretty easily and generate a steady stream of profits.
For years, Waste Management has taken these competitive advantages and turned them into a very shareholder-friendly business. For more than a decade, the company has steadily raised its dividend payments and bought back shares to generate high rates of return in what many would consider a slow-growth business.
For beginning investors, companies with huge competitive advantages like Waste Management are a great lesson in why it pays to hang onto stocks for the long term. The company's share price gains will never blow anyone's socks off, but its high rates of return in an industry that will likely be around for decades will reward those who hold onto their position.
The transition is working
Brian Feroldi (Microsoft): I'm a firm believer that new dividend investors should seek out big, highly profitable companies for their first investment. That criteria perfectly describes Microsoft, which is why I think it's a fantastic stock for beginners.
Microsoft has been cranking out profits for decades thanks to its stranglehold on the software industry. Products such as Windows and Office are cash cows that have been a dependable source of revenue for decades. That should hold true for a long time to come.
However, Microsoft's stock stagnated for years over worries that the ever-changing tech world would render this company's products obsolete. Thankfully, that worry got put to rest when Satya Nadella took over the top chair in 2014. CEO Nadella has placed an emphasis on moving Microsoft's products into the cloud, a decision that's paying off handsomely as revenue from products like Azure, Office 365, and Dynamics CRM Online are surging. When you add in the growth of other product lines such as Xbox, Bing, and Surface, Microsoft's bottom line has been posting healthy gains in recent years.
Looking ahead, market watchers believe Microsoft's bottom line will grow by more than 9% annually over the next five years. That seems realistic when combining the growth in cloud product sales with its recently completed acquisition of LinkedIn. Add to that the company's rock-solid dividend yield of 2.4%, and I can't help but think Microsoft is a terrific stock for new dividend investors to buy.
Buy one of Buffett's favorites at a great value
Jason Hall (American Express): Warren Buffett first bought shares of American Express when the company's stock was selling for bargain prices. Decades later, those shares are worth almost 10 times what Berkshire Hathaway paid -- but that's only the tip of the iceberg of what American Express means for Buffett and Berkshire today.
At the current $0.32 per share quarterly dividend, American Express will pay Berkshire almost $195 million in dividends in 2017. That may seem like a paltry yield on its $12 billion stake, but when we look at the yield on cost -- that is, how much American Express' dividend pays based on the original investment -- the math is much better: Berkshire gets paid a roughly 15% yield on its cost for those AmEx shares. And with its prospects and track record, that payout is likely to keep growing for years to come.
There's a wonderful lesson for beginning investors: Don't skip the small-yielding stocks if you're looking for dividends. Sometimes your best choice is one like American Express, which has spent far more time yielding below 2% of its market price than above 3%, but it has steadily and regularly raised its dividend for decades:
Don't let today's paltry yield cause you to miss an excellent dividend growth stock. American Express stock is cheap today, trading near 14 times last year's earnings. And with its track record of dividend growth, it could be paying you 15% or more on your original investment in a couple of decades.
The company at the core of our digital world
Chuck Saletta (Cisco Systems): Cisco is the ubiquitous networking giant responsible for many of the high-speed routers and switches that move financial transactions, videos, pictures, and text all over the internet. It's also establishing itself as a strong dividend player with both a decent history of increasing its dividend and reasonable room to continue raising it going forward. That combination sets it up as a great potential investment for someone just now dipping into the realm of dividend investing.
Cisco paid its first dividend of $0.06 per share per quarter in 2011, and it has been increasing it since then. The company's current yield is almost 3.5%, which is a decent premium over the general market. It recently raised its dividend from $0.26 per share per quarter to $0.29, an increase of 11.5%. Even with that increase, Cisco pays out only around half of its earnings in the form of dividends, which gives it room to continue increasing those dividends as its business grows over time.
Speaking of that growth, over the next five years, analysts expect Cisco to be able to increase its earnings by almost 11% per year. If it does manage to grow at that pace, and its dividends follow suit, investors will receive around $0.48 per share per quarter five years from now. That's the true power of a strong dividend investing strategy.
Learn from a great
Jordan Wathen (Costco): Warehouse retailer Costco is neither cheap nor especially high-yielding, but it is the kind of company I'd recommend to a friend as a company to follow and learn from.
Costco has more traits of the "greats" than perhaps any other company. For one, it has the advantage of efficient scale, which results from the fact it generates about $120 billion in revenue from just 4,000 products, thus frequently making Costco its suppliers' single-largest customer. That gives it power at the negotiating table.
It's also ridiculously good at managing its balance sheet. Costco manages to sell its inventory before the bill even comes due.
Oh -- and it somehow created a cult following that Forbes once dubbed "Costcoholics" for the fact that its loyalists visit the store several times a week to see what's new. Not many retailers have rabid fans of their off-label brands, but Costco does.
Let's get back to the dividend. Costco's current yield of 1% understates its heft as a dividend stock. I think it's likely that dividends will grow at a double-digit clip for years to come, as its earnings power increases and it pays out a greater percentage of earnings to its shareholders. What's more important, especially for beginner investors, is the opportunity to use the company as a case study to learn about what separates the good businesses from the great businesses.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's Board of Directors. LinkedIn is owned by Microsoft. Brian Feroldi has no position in any stocks mentioned. Chuck Saletta owns shares of Cisco Systems and Microsoft. Jason Hall owns shares of American Express, Berkshire Hathaway (B shares), Cisco Systems, Costco Wholesale, and Waste Management. Jordan Wathen has no position in any stocks mentioned. Tyler Crowe owns shares of Berkshire Hathaway (B shares), Costco Wholesale, and Waste Management.
The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Costco Wholesale. The Motley Fool owns shares of Waste Management. The Motley Fool recommends American Express and Cisco Systems. The Motley Fool has a disclosure policy.