Now more than ever, investors have begun to fully appreciate the value of dividend-paying stocks. When you aren't so sure about whether stocks will continue to give you the long-term gains they've provided historically, nothing boosts your confidence more than getting cold hard cash deposited into your brokerage account every three months.
One debate among dividend investors, though, involves whether you should go for maximum current yield now, or instead seek out companies that will grow their dividend payouts over time. Although many are tempted to take the money and run, high yields often mask problems that pose big threats to your investment. By contrast, more modest dividends from companies that have a long track record of success can give you exactly the risk profile you want.
But you don't want to be too modest with your yields. Unfortunately, some stocks that have achieved an important mark of dividend success nevertheless don't give shareholders everything they truly deserve. We'll turn to those overrated companies later in this article, but first, let's look at the dividend phenomenon and how it's gained such importance among investors.
Hungry for income
Dividend stocks have become popular for two main reasons. One has to do with the predictability of dividends compared to the uncertainty of capital gains. You can't be sure whether or when a stock you own will rise in value, but for the most part, companies do their best to make their dividends regular and dependable.
In addition, the number of good alternatives that income-seeking investors have has dwindled substantially in recent years. With the Federal Reserve's policy keeping interest rates near zero and a huge bull market in bonds, interest yields are near record lows. Cash-strapped savers have had little choice but to look for high-quality dividend stocks to boost their portfolio income.
In terms of safety, companies with long streaks of raising their dividends annually have demonstrated their ability to survive and thrive throughout tough economic environments. Companies like those on the Dividend Aristocrats list, which requires annual dividend increases for at least 20 straight years, have proven their consistency.
But just because you have a long history of rising dividends doesn't mean that those payouts are automatically high enough. Consider these companies:
has raised its dividend payout for 34 years in a row. But the stock yields just 1.1%, with a fairly stingy 30% payout ratio. Despite modest historical earnings growth, investors have bid the shares up by 90% in the past year, leading to an expensive valuation of nearly 29 times trailing earnings. (NYSE: SHW)
has an impressive 26-year dividend streak. Yet it yields just 1% and pays less than a quarter of its earnings in dividends. The company appears to have gotten the message at least partially, having raised its payout twice in the past three quarters. Hopefully, Donaldson won't revert to its historical practice of quarter-cent dividend increases and will keep making meaningful boosts in the future. At 21 times earnings, though, it's valued pretty fully at this stage. (NYSE: DCI)
boasts 41 years of dividend increases. At 1.5%, its yield is somewhat healthier than its peers here, but its earnings multiple of 21 suggests that the impressive run its stock has made may be topping out. Grainger seems to recognize the problem, having made nice payout boosts in recent years, but quicker action would make shareholders happier. (NYSE: GWW)
- Like Sherwin-Williams, Valspar
is in the paint business, with a 34-year record of rising dividends. But its $0.01 and $0.02-per-share increases in its dividend haven't kept up with its earnings growth, leading to a current yield of just 1.6%. A big one-time charge made the company post a loss over the past 12 months, but on a normalized basis, Valspar has plenty of room to raise payouts further. (NYSE: VAL)
- Finally, Tootsie Roll
has a skimpy 1.3% dividend yield, despite having raised its payout annually for the past 47 years. Fetching a lofty 33 times earnings, the candy company seems overpriced, but the dividend represents only 40% of the company's per-share income. (NYSE: TR)
Open the purse strings
Of course, one way that companies sustain long streaks of dividend increases is by being conservative during the good times. That way, they bank some breathing room to get through the bad times.
But for companies with long histories of success, paying out yields this low is being overly cautious. Seeking to get their yields above the 2% level that the broad market pays on average is a perfectly reasonable goal for these dividend stalwarts to strive for in the near future.
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Fool contributor Dan Caplinger is a dividend hog. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy never stops rewarding you.