The past year has been brutal for dividend-focused investors. Companies that not long ago were considered bastions of dividend fortitude -- Citigroup
There's plenty of reason to be sore about those dividend cuts: Mind-blowingly thorough research from Wharton professor Jeremy Siegel shows that dividends are a crucial driver of long-term market outperformance.
But rather than spend the rest of this recession hiding under a rock, we dividend-loving investors can profit. Yes, many companies are cutting their dividends, but there are plenty of stocks not only maintaining their dividends, but growing them -- 85 in February alone!
Spotting the long-haul winners
As we've seen, cuts happen. But fortunately, identifying dividend payers with sustainable, growing payouts isn't exactly rocket science -- you just need to know what you're looking for.
Companies with long, uninterrupted histories of dishing out dividends typically share these three traits.
1. They rake in cash.
Healthy dividends are funded with free cash flow, which means that prodigious cash generation and dividend safety go hand in hand. Dividend aristocrat Procter & Gamble
2. They aren't cyclical.
During boom times, profits in a cyclical industry flow like a Saudi oil well, often leading management teams to overcommit to high dividends and significant expansion (picture miner Freeport-McMoRan or shipping giant DryShips). When a cyclical industry tightens up (and such industries always do), cash profits follow suit, and once-high dividend payouts quickly find themselves on the chopping block.
3. They are conservatively capitalized.
Even well-run companies that aren't in cyclical industries can occasionally find themselves on the outs. Look for companies that consistently produce operating profits well in excess of their debt obligations.
By looking out for companies that demonstrate these qualities, you're setting yourself up to find the next great dividend winner.
A company that recently caught my eye -- and that demonstrates these three qualities -- is Motley Fool Income Investor Buy First recommendation Waste Management
Trash and cash
Waste Management operates in a pretty mundane industry. But your trash is Waste Management's cash -- the company turns a stellar 10% of its revenue into free cash flow and pulls in operating profits about three times that of its interest expense. And while declines in industrial trash collection have slowed growth, as those of us who routinely lug our trash to the curb can attest, demand for residential trash collection is extremely consistent.
Owning shares of Waste Management is a bit like a having a stake in a collection of small near-monopolies. Building a landfill requires a lot of cash, involves miles of red tape, and faces intense blowback from the locals. These challenges keep competition at bay and have helped lead to consolidation in the industry.
It gets better
For starters, there's no real chance that technological obsolescence will undercut Waste Management's service offering. Similarly, unlike, say, Cisco Systems or Gilead Sciences
And unlike with oil, gasoline, and other high value-to-weight commodities, it doesn't make economic sense to haul trash over long distances. That means you don't have to worry about distant competition threatening your localized pricing, as it often does in other industries. By way of comparison, that means waste haulers will never find themselves playing the tragic role of Blockbuster in "Netflix
Now, take the ability to set local prices with minimal competition, combine it with the rational pricing of this consolidating industry, and it's little wonder that Waste Management and the other major waste haulers are able to push around their customers, consistently raising prices on their largely captive customer base.
Dumping it all together
There's a lot to love about such sturdy, growing dividend payers -- just ask one of the company's largest investors, Microsoft's Bill Gates. Waste Management is typical of most Income Investor recommendations: strong, well-managed, and boasting healthy cash flows and a sustainable dividend.
On the surface, there isn't much pizzazz to dividend-focused investing, but as Jeremy Siegel's research and Income Investor's results have shown, the strategy is a proven winner.
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This article was first published Aug. 29, 2008. It has been updated.
Joe Magyer owns shares of Waste Management, which is a recommendation of both Income Investor and Inside Value. Microsoft is an Inside Value recommendation. Netflix is a Stock Advisor recommendation. The Motley Fool owns shares of Procter & Gamble. There's nothing trashy about the Fool's disclosure policy.