As investors transition from the asset accumulation phase of their lives to the asset distribution phase, capital preservation takes priority over growth. In addition to bonds and risk-free assets like Treasury notes or certificates of deposit, dividend stocks can be an excellent way to supplement income in retirement. However, not all dividend stocks are created equal, as some companies pay large dividends they can't afford or don't regularly increase their dividend distributions. That's what makes Dividend Aristocrats so unique.
This class of companies has paid and raised their dividends for at least 25 consecutive years, which adds a layer of trust to the investment thesis. What's more, Dividend Aristocrats tend to be industry-leading companies with diverse and global businesses. Target (TGT -0.44%), Caterpillar (CAT 0.44%), and Emerson Electric (EMR -0.51%) are three that stand out as top buys now. Here's why.
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The worst of Target's inventory crisis may be over
Daniel Foelber (Target): Target and fellow big box retailer Walmart have been particularly impacted by inflation as customers curb spending on discretionary purchases. During its Q1 2022 earnings call, Target told investors that it had too much inventory in the wake of a slowdown in consumer spending.
Unsurprisingly, Q2 was chock-full of large discounts to try to push inventory out in time for the shift to the fall and holiday season. The discounts may have allowed Target to sell more products and achieve impressive revenue growth. But the steep sales also took a sledgehammer to its operating margin and earnings.
TGT Operating Margin (Quarterly) data by YCharts
The silver lining is that the worst may be over for Target as the company believes its inventory levels are more reasonable now and better position the company for the holiday quarter. It's understandable that Target would mismanage inventories given the volatile rise and fall in COVID-19 cases paired with ongoing supply disruptions. After all, forecasting is a big part of Target's business. And forecasting has been very difficult for retailers over the last couple of years.
Even if Target continues to struggle in the near term, the company remains an industry leader that has successfully invested in e-commerce and curbside pickup. The stock has a price-to-earnings ratio of just 14.3 and a dividend yield of 2.5%. What's more, Target is a Dividend King that has paid and raised its dividend for 50 consecutive years.
For investors looking for a reliable passive income stream from a company that is easy to understand, Target stands out as a no-brainer buy now.
A Dividend Aristocrat for the ages
Lee Samaha (Caterpillar): The construction, mining, energy, rail, and industrial equipment company Caterpillar may seem an odd candidate for a reliable dividend stock -- after all, its earnings and cash flow are highly cyclical and fluctuate with the economy.
That said, there are three key reasons why Caterpillar fits the bill. First, the company has already demonstrated its commitment and ability to increase dividends for shareholders, having done so for 29 consecutive years.
Second, management acknowledges the cyclicality in its earnings, but it believes its underlying free cash flow will be in the range of $4 billion to $8 billion through the economic cycle. Second, given that the last dividend payout was about $2.3 billion, Caterpillar's dividend is well covered through the cycle.
Third, management's emphasis on growing its services revenue will reduce its earnings' cyclicality. Indeed, during the recent earnings call, management confirmed it was on track to double its services revenue from $14 billion in 2016 to $28 billion by 2026. Last year's total company revenue was $51 billion.
Meanwhile, although cyclical, Caterpillar's end markets are set for long-term growth. So as long as there's a need for physical products, infrastructure, transportation, and buildings, there'll be a need for its machinery.
A regal choice to put a charge in your passive income
Scott Levine (Emerson Electric): During the recent downturn in the markets, many retirees -- or those near retirement -- likely feared that their golden years could lose some luster. For those who have fortified their retirement portfolios with resilient stocks, however, the fears may have been less severe. Resilient dividend stocks, in fact, are an even greater choice, which is why the Dividend King Emerson Electric and its forward dividend yield of 2.3% represents a compelling option for passive-income-hungry investors.
Primarily, retirees are looking to supplement income with conservative investments that have minimal risk. To this extent, Emerson Electric is an ideal choice. The company, which specializes in automation as well as climate control technologies, has consistently increased its payout to shareholders for 65 years. That's no small feat; in fact, there are few other companies that can boast of such an impressive accomplishment.
Delving into the company's financials, investors will find the main reason why Emerson Electric is able to regularly hike its dividend: the generation of strong free cash flow. And it's not as if the company is only rewarding shareholders with the cash that it generates; Emerson Electric is also returning capital to shareholders by way of stock buybacks. In 2022, for example, Emerson Electric forecasts free cash flow generation of $2.5 billion, dividend payments totaling $1.2 billion, and $500 million in share repurchases.
EMR Dividend Per Share (Annual) data by YCharts.
For those looking to buttress their retirement portfolios with a strong dividend stock that's also on the sale rack, Emerson Electric should be on their radars. Shares are currently trading at 16.4 times forward earnings, representing a discount to their five-year average multiple of 19.9 times forward earnings.
