Whether you're new to investing or have been at it for a lifetime, you need to understand the business models of the companies you invest in. Understanding exactly how a company makes money greatly reduces your overall investing risk.
In that spirit, today we're going to look at three companies with straightforward business models and strong dividends, focusing on companies that have been around awhile and look like they're going to stay around. After all, what good is a great dividend if the company won't be there to pay it out?
Without further ado, here are three big, safe dividend stocks for the beginning investor, along with my personal favorite and my reasons for choosing it.
Whether it's Windows OS, Microsoft Office, or Sequel Server, almost anyone who's used a computer over the last 30 years has used a Microsoft product. Together with Apple
There's no secret to how Microsoft makes money: It makes and sells software for personal and commercial use. Nice and straightforward. Now let's have a look at some important numbers for the software giant:
- We normally like to see dividend yields of around 3% -- an arbitrary threshold, but one we feel separates the wheat from the chaff. Microsoft only pays 2.6%, but the company is so dominant in its sector -- still such a steady cash-generator -- that it's still worth considering. Apple will begin paying a dividend for the first time later this year, and it's expected to yield about 1.8%.
- We like to see dividend payout ratios of 50% or less. The lower the percentage, the more sustainable. At 26%, Microsoft's is very sustainable, and it's almost exactly the payout ratio that Apple is projecting to come out at when it starts paying its dividend.
- Gross margin is an indicator of brand strength, pricing power, and management and manufacturing efficiencies -- factors that directly affect the bottom line. Microsoft has a whopping 76.6% trailing-12-month gross margin. Apple, for all its headline-grabbing dominance, only manages 44%. It helps Microsoft enormously that it doesn't have to manufacture hardware, as Apple does.
Microsoft has a five-year average dividend yield of 2%, and it just turned in solid, if not astonishing, quarterly results, with revenue growth of 6% year over year and more than $58 billion in cash on the balance sheet. Microsoft isn't going anywhere anytime soon.
2. Procter & Gamble
Here's a classic corporate name that's not in your face every day but likely touches your life on a day-to-day basis. Think of brands like Tide, Pampers, Iams, Gillette, and Duracell. These, and scores of other leading brands, are all manufactured by P&G. They are time-tested products that people use every day -- and rarely even consider switching from when they're at the grocery store.
Let's have a look at some important numbers for the Cincinnati-based home products giant:
- We said we look for a 3% yield on our dividend stocks, and at 3.5%, P&G doesn't disappoint.
- The company's payout ratio, at 64%, is a bit on the high side, but not dangerously so.
- Gross margin for P&G is a healthy 49.4% TTM, easily beating the industry average of 45.8%.
Net sales for the most recent quarter were up 2% year over year -- again, not breath-taking, but solid for a company that's 175 years old. P&G presents us with a beautiful, no-brainer business model -- just the way we like it.
Here's another straightforward business model for you. Burger, fries, drink -- repeat endlessly. People need and like to eat. Give them great-tasting food, and you have an easy recipe for success. How many billions has McDonald's now served? I've personally lost count, but I can assure you it's a lot. Let's have a look at some important numbers for the Golden Arches:
- The company pays a dividend of 3%, just making our benchmark and easily besting rival Yum! Brands'
1.6%. (NYSE: YUM)
- At 49%, McDonald's dividend payout ratio is right in the pocket. Yum! does even better on this metric, coming in at 34%. McDonald's 49% is just fine, though.
- With a gross margin of 39.6% TTM, McDonald's not only beats the industry average of 30.6%, but also bests Yum!'s 26.7% handily.
McDonald's five-year dividend average of 3.1% bodes well for the current 3% yield's longevity. Speaking of longevity, McDonald's has been around since 1940, and with healthy quarterly revenue growth of 7.1% YOY and robust international expansion, it looks set be around for a while longer.
And the winner is ...
I'm going to err on the side of caution and great-tasting French fries here. Like many of America's fast-food chains, McDonald's is still really just getting started overseas. There's room for tremendous growth there, and McDonald's is exploiting it as well as, or better than, anyone else. Again, people will always need to eat, and McDonald's food not only tastes great but is inexpensive as well, making it perfect for emerging markets. I think it's a company you can count on for years to come.
There you have it: three great companies with business models investors can get their heads around and stocks that offer some of the market's best, most sustainable dividends. If today's column has left you wanting more, check out this free Motley Fool special report: "Secure Your Future With 9 Rock-Solid Dividend Stocks." The title says it all. Get your copy while the stocks are hot by simply clicking here now.