When you have a long-term mindset, a stock's ability to appreciate quickly becomes a secondary consideration. Primarily, you're looking at what a business can do over decades to come. An appropriate component to a long-term portfolio is a stock that pays dividends, because payouts provide the juice to total returns.
We asked three contributing Motley Fool investors to identify companies they believe would reward investors with long time horizons with both income and capital appreciation. See how Gilead Sciences (GILD -0.54%), Johnson & Johnson (JNJ -0.37%), and Tailored Brands (TLRD) could offer this winning combination.
A beaten-down biotech with a rising dividend
Keith Speights (Gilead Sciences): The last couple of years haven't been fun for Gilead Sciences shareholders. The biotech's stock has plunged with slumping sales of hepatitis C drugs Harvoni and Sovaldi. Gilead's primary problem stems from a positive development: So many hep C patients have been cured by the company's drugs that new patient starts are declining.
But while Gilead stock has dropped, its dividend has increased. The big biotech first initiated a dividend program in 2015 and has increased its payout by 10% each year since then. Gilead's dividend yield now stands at 2.94%. The company currently uses just over 20% of earnings on funding the dividend, indicating plenty of room to keep the dividend hikes coming even with its hep C challenges.
Dividend-paying drug stocks like Gilead are well-suited for investors with long-term perspectives. When scenarios such as Gilead now faces come along, an opportunity opens up to buy shares at an attractive price and lock in great dividends. Long-term investors also understand that there's usually a light at the end of the tunnel for well-run companies. I think that's the case for Gilead.
The biotech has one of the largest cash stockpiles around -- and it intends to use it. Gilead's executives have underscored the company's goal to make one or more acquisitions to spur growth. While anxious short-term traders worry about how quickly Gilead will make a deal, long-term investors can enjoy the solid dividends and appreciate that the company isn't likely to make a too-hasty decision on which smaller company to acquire.
Three businesses rolled into one
Brian Stoffel (Johnson & Johnson): When I think about the best dividend stocks to own, I consider two characteristics above all else: a wide moat and sustainably high levels of free cash flow. In both respects, I believe Johnson & Johnson is a worthwhile candidate for long-term investors.
The healthcare conglomerate has three different lines of business. Consumer products like Band-Aids and Tylenol accounted for 19% of sales last year and are protected by the time-tested strength of the individual brands in the company's portfolio.
Medical instruments contributed another 35% of sales, with a focus primarily in spine and general surgery procedures. These products, once bought, create recurring revenue for the company because the hospitals that purchase them face high switching costs, as a product's steep purchase price needs to be justified through continued utilization.
And finally, there is the pharmaceutical division, which chipped in the largest share of sales last year at 46%. The two most important of the company's drugs were arthritis medications Remicade and Stelara. While profits can be huge from this division, the moat is admittedly narrower, as all drug patents eventually expire.
Just as important as moat size is yield -- and Johnson & Johnson's current yield of 2.5% is very safe. Over the past 12 months, the company produced over $16 billion in free cash flow, but used only 53% of it to pay its dividend. Given that, I don't see any reason to believe the company's history of 55 consecutive years of dividend increases will be interrupted.
A custom-tailored dividend stock
Rich Duprey (Tailored Brands): It may seem a bit far-fetched to recommend a bricks-and-mortar retailer that has suffered a series of setbacks over the past few years, but there are some very good reasons that men's suits leader Tailored Brands could be the perfect fit for investors with a long-term mindset.
Let's get the ugly out of the way: Tailored Brands, which used to be known as Men's Wearhouse, made two big mistakes a few years ago -- it ousted company founder George Zimmer and it bought rival Jos. A. Bank. The first move created internal turmoil as it took away Zimmer's vision, while the second tried to thread a stumbling and completely different corporate culture into the fabric of a successful business.
Jos. A. Bank was famous for its "buy one suit, get three free" advertising; Men's Wearhouse pushed everyday low pricing. When the latter tried to impose its pricing strategy on the former, customers abandoned the clothier in droves. Men's Wearhouse then had an ill-fitted partnership with Macy's (M 0.39%) for tuxedos that was recently ended. On top of all these problems, its Twin Hill uniform division had a nasty public relations disaster brewing with American Airlines (AAL 2.15%) over supposedly rash-inducing uniforms. The two companies just parted ways.
Yet Tailored Brands has a lot to look forward to. Jos. A Bank has posted two straight quarters of positive comparable sales (though its other smaller brands turned negative), and suits should be fairly resistant to e-commerce competition. While there are a number of sites selling suits online, and Tailored Brands has its own e-commerce site, most people still prefer to be able to try on a suit before buying, particularly if one is being custom-made. An analyst at Morgan Stanley says suits should be somewhat resilient to encroachment by Amazon.com and other online chains.
Tailored Brands stock is down 56% so far in 2017 and trades at just five times the free cash flow it produces. With a $0.72 dividend that currently yields 6.7% as the market frets about bricks-and-mortar retail, patient investors should be rewarded by the turnaround that will come.