In terms of popularity, Lady Gaga's got nothing on dividends.
This isn't hyperbole -- according to Google News, "Lady Gaga" has appeared in 15,200 articles over the past month, while "dividends" appeared in 16,800 articles.
Going gaga for dividends
With near-record low interest rates, it's easy to understand why dividends are a hot topic today. As our Foolish colleague Morgan Housel noted here, the dividend yield on the S&P 500 recently moved above the 10-Year Treasury bond yield for the first time in over half a century.
Should this be taken as a sign that investors should go all-in on stocks today? In our opinion, no.
Forgive us, but we're not quick to give an "all clear" to stocks just yet. Yes, there are some tremendous long-term values out there (we'll get to those in a minute), but the economic recovery will likely be slow and could take a number of years to work itself out.
As a result, we prefer to buy dividend-paying stocks slowly and deliberately over time and allow our reinvested dividends to compound. This way, we can keep a decent chunk of cash on the sidelines, just in case the market takes another turn for the worse.
Dividend reinvestment plans (DRIPs) are an excellent vehicle for this approach and it's why Bryan and I (Todd here) brought back the Foolish DRIP portfolio, where we put our own money into the stocks we recommend.
Going gaga for dividend growth
Sure, historically dividends have made up a good chunk of long-term stock returns, but the real sweet spot is finding dividend growers and hanging on for the ride. Below, Todd and I (Bryan here) have teed up five of our favorites, which based on their payout ratio, free cash flow generation and business prospects would be great candidates for a DRIP portfolio.
The duck that will rule the world
In the United States, Aflac (NYSE: AFL) is the top duck in supplemental disability and life products, with 31% of the market. But what you may not know is that the company also has a 21% market share of supplemental insurance in Japan, thanks to a first-mover advantage and strict regulation. The company has more room to grow in both of these current markets and a bunch of the world yet to conquer. Over the past five years, Aflac has grown its dividend by 24% per year and still only pays out 35% of its earnings.
Plumbing for payments pays off
Total System Services (NYSE: TSS) rules the credit and debit payment processing infrastructure, which has led to free cash flow growth of 11% per year over the past five. TSYS, as the company is called, doesn't plan on stopping its growth and is vertically integrating merchant services through a new joint venture. As TSYS grows its revenue, earnings and cash flow we expect its dividend to grow as well. Better yet, we aren't concerned about having enough cash to fuel upgrades and new business initiatives because the company only pays out 26% of profits.
Portfolio and home improvement
With employment and home sales where they are, Lowe's (NYSE: LOW) is facing some headwinds. CEO Robert Niblock sees 2010 as "a year of transition for the home improvement industry." Nevertheless, shares look pretty cheap based on their historical EV/EBITDA, P/FCF and P/B ratios. Patient investors should see the company's already growing dividend continue to grow as home improvement spending returns to more normal levels. And because Lowe's only paid out 22% of its earnings last year it looks to have room to hammer out additional dividend growth.
Dividends with "bling"
Jewelry maker Tiffany (NYSE: TIF) is an American icon that dates back to 1837, but don't let its age fool you -- it still has plenty of room for growth. In the past quarter, while other companies were struggling to sell big ticket items, Tiffany actually had the opposite problem where sales of high-end products increased while items priced below $500 limped along. International growth has continued as sales in China, Hong Kong, Macau, and Korea were up 20% year-over-year. The 2.2% dividend is well covered by free cash flow, the balance sheet is healthy, and the payout ratios are low, giving Tiffany all the makings of a good dividend growth stock.
Want some jam with that toast?
With J.M. Smucker's (NYSE: SJM) acquisition of Folgers coffee from Procter & Gamble (NYSE: PG) in 2008 to complement its already wide product list of jams, jellies, peanut butter, and biscuits, it secured a dominant place on your breakfast table. And now that those major acquisition costs have receded, Smucker has returned to being a free cash flow generating machine, throwing off about $575 million in free cash over the past 12 months. This puts shares near 12.8 times trailing free cash flow -- a fair price to pay. Plus, Co-CEOs Tim and Richard Smucker together own more than $200 million of company stock and have the family name sake to keep them motivated. Its 2.6% yield is also well-covered and has room to grow.
Foolish bottom line
Remember Fools, slow and steady wins the race. Invest what you can afford to when you're comfortable doing so. Each of these promising companies offers you the opportunity to add small amounts of money into their stocks each month or quarter via their DRIP plans.
Bryan and I (Todd again) will be considering each of these stocks for inclusion in our real-money DRIP portfolio in the coming months. If you'd like to follow our analysis, you can do so on Twitter or by checking our DRIP Portfolio Wiki page.
Todd Wenning owns shares of Procter & Gamble. Bryan Hinmon, CFA doesn't own shares of any company mentioned, but does have a neat collection of arrowheads. Aflac is a Motley Fool Stock Advisor choice. Procter & Gamble is a Motley Fool Income Investor recommendation. The Fool owns shares of and has written covered calls on Procter & Gamble. The Fool owns shares of Lowe's Companies, which is a Motley Fool Inside Value recommendation.
True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.
