Investors love to find catalysts for their stocks. Special situations such as spinoffs or restructurings can unlock hidden value and produce accelerated returns. It's an attractive way to play the market, and it's a method I follow in my Rising Stars Portfolio. But many investors overlook one of the best catalysts for stoking capital gains -- dividend increases -- since an increase signals management's confidence in the business prospects.
Special situation, meet income investing
If you've clicked on this article, you probably love dividend stocks as much as I do. I've written extensively about income investing, detailing the dividend play for a lifetime, the outstanding dividend stock I was buying in January, and other high yields to own for decades. But I think you can do even better by combining your focus on dividend payers and special situations.
At its heart, special situations investing is about finding specific events, such as forced selling of a spinoff, that aren't yet reflected in stock prices for technical reasons rather than fundamental business reasons. Such events often create big inefficiencies in the market.
For dividend investors, special situations could involve companies that have just started a dividend. While many investors regard a dividend initiation as a tacit admission that the company cannot grow as fast as it once did and therefore exit the stock, a dividend also draws in a whole new investor base, too. Because income-focused indexes and other funds cannot buy a stock until it pays a dividend, there's pent-up demand for shares.
And now for the contenders...
Below are five companies that can boast above-trend dividend growth and may benefit from a rapid dividend increase or an initiation:
||1.3%||The world's largest communications equipment company has initiated a dividend|
||3.2%||The company has committed to paying out all free cash flow, either as dividends or buybacks|
||3.6%||The company has promised a "progressive" dividend policy as earnings ramp and a 50% dividend raise|
||3.6%||BP has also promised a progressive dividend policy|
Church & Dwight
||1.7%||The company bumped up the dividend by 100% in the latest quarter, on top of a 21% bump in mid-2010|
Cisco has decided that it wants to join the dividend game and now offers a 1.3% yield, a payout ratio of just 14% of free cash flow. That leaves plenty of room for accelerated dividend growth, and the stock could benefit from market inefficiencies as well, as funds rush in. With the stock trading at 11 times its free cash flow and sitting near a 52-week low, there are few expectations built in here. The situation is largely similar for blue-chip stalwart Microsoft
McDonald's has become a dividend darling in the last half-decade (at least for me.) In that period, the company has plumped its payout at a 27.5% annual rate. While that type of growth can't continue indefinitely, the company has already committed to paying out all its free cash flow as either dividends or buybacks. And the company has other hidden assets, as I explain here.
I'm attracted to Seaspan for the improving industry fundamentals and the company's promise of a progressive dividend policy, suggesting that payouts will increase at an above-average rate. Indeed, the company bumped the divvie by 50% just recently. Andy Cross, co-advisor of Motley Fool Hidden Gems, bought the stock for the newsletter's real-money portfolio last year and has seen a stellar 90% gain in just nine months. But with Seaspan's looming dividend increases, I think there's plenty more upside.
The catalyst for BP is much the same as it is for Seaspan: a progressive dividend policy that can show above-trend increases. BP was widely held by income investors in the U.S. and U.K. for its yields in the range of 5.5% to 6%, and the recent resumption of its dividend (albeit at half the previous rate) should bring yield-hungry investors and funds back to the fold, especially as oil prices continue to rise.
Investors in Church & Dwight have a lot to be happy about following the company's doubling of the payout. Since the announcement on Feb. 8, the stock has run up 15%. This mid-cap player in the consumer goods space can't boost the dividend at that rate forever, but its free cash payout sits at just 27%, so there's clearly room for above-average gains.
Follow these dividend stars
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Do you have a dividend stock that the market hasn't appreciated yet? Let me know in the comments below.
Jim Royal, Ph.D., owns shares in McDonald's, Microsoft, and Church & Dwight. Microsoft is a Motley Fool Inside Value recommendation. Starbucks is a Stock Advisor selection. McDonald's is an Income Investor pick. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Options has recommended a diagonal call position on Microsoft. Motley Fool Options has recommended a write covered strangle position on Seaspan. The Fool owns shares of Microsoft, Seaspan, and Starbucks. Motley Fool Alpha LLC owns shares of Cisco Systems and Microsoft. 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 has a disclosure policy.