Dividends are powerful wealth-builders. Between January 1926 and December 2006, 41% of the S&P 500's total return owed not to the price appreciation of the stocks in the index, but to the dividends paid out by those companies.
But not all dividends are created equal. Here's how to find the best candidates for your portfolio.
Consistency counts
Look for reliability. The S&P 500's list of "Dividend Aristocrats" features the elite of the dividend world: companies that have increased their dividends for 25 years in a row.
If a company has not missed a year for a quarter of a century, you can bet that it has good control of its operations, and that it will not want to miss a year and fall off the list. The current 43-member list, including ExxonMobil and Target, adds up to more than 1,075 years of dividend increases!
Protect that payout
Look for sustainability. A too-high payout ratio is a red flag that can warn you about potential dividend cuts in the future. The payout ratio is the percentage of net income paid out in dividends; if a company is giving most or all of its income back to shareholders, it won't have much cash left for other needs. If revenue drops sharply, that company will likely have to cut its dividend.
There's no perfect payout ratio to look for; they can vary by industry. But in general, the lower the percentage, the safer the dividend. Anything above 80% could warrant caution, as these companies with high payouts may reveal:
|
Company |
Recent Dividend Yield |
Payout Ratio |
|---|---|---|
|
Boeing |
2.5% |
101% |
|
National Semiconductor |
2.3% |
114% |
Data: Motley Fool CAPS.
Boeing's steep payout ratio stems from the halving of its net income being in 2009, owing partly to much higher research and development costs. National Semiconductor also experienced a huge drop in income recently, but the cyclical company should benefit as the economy turns around.
Generosity and growth
Ideally, you want a sizable dividend payout. What good is a dividend stock without the income? US Bancorp
US Bancorp's low payout ratio suggests that it has a lot of room for growth on the dividend front. Over the long haul, expected dividend growth is arguably more important than a stock's initial yield, since it can boost a modest yield into a payout powerhouse.
Better yet, look for companies with respectable yields and promising growth rates, such as these:
|
Company |
Recent Dividend Yield |
5-Year Avg. Dividend Growth Rate |
Return on Equity (ttm) |
Net Profit Margin |
|---|---|---|---|---|
|
Coca-Cola |
3.3% |
10.1% |
31% |
23% |
|
Intel |
3% |
23.6% |
15% |
16% |
|
Pfizer |
4.4% |
7% |
11% |
14% |
|
Procter & Gamble |
3.2% |
11.9% |
18% |
16% |
Data: Motley Fool CAPS.
These are simply candidates for your own future research, but their strong brand names, robust ROE and net margins, and massive presence in the U.S. and around the world all bode well for their prospects.
The Foolish bottom line
Ignore the power of dividends at your own peril -- they're a terrific way to boost your wealth over time, while helping you sleep easier.
If your portfolio isn't laden with at least a handful of dividend payers, consider adding a few. We'd love to introduce you to many promising ones in our Motley Fool Income Investor service. On average, its picks are beating the market by six percentage points. Click here to learn more about our free, no-obligation, 30-day trial.
