Investing in solid dividend stocks can be one of the simplest and most effective strategies to obtain market-beating returns over time. However, investors need to be careful when picking dividend stocks. A solid trajectory of dividend payments is a great thing, but that alone does not make for a sound investment decision.
AT&T (NYSE:T), McDonald's (NYSE:MCD), and Philip Morris International (NYSE:PM) all offer a sound track record of dividend growth. On the other hand, the three companies also face considerable challenges and expose investors to big risks in the middle term. Let's explore why these stocks may not be the best options in 2015.
AT&T raised its dividend in December, marking the 31st consecutive year of uninterrupted dividend growth at the telecom giant. The new dividend yield stands at a compelling 5.6%.
On the other hand, AT&T's dividend hike last year was a minuscule 2.2%. This was clearly not a temporary slowdown -- the company has, in fact, raised its dividend by just a penny per share annually over the last seven years. So while the yield looks strong, dividend growth leaves much to be desired.
AT&T operates in a challenging and intensely competitive environment, and finding profitable growth opportunities is proving difficult. Sales during the third quarter of 2014 increased by a lackluster 2.5% year over year, while operating earnings actually contracted 12.7% from the same quarter in 2013.
The company produced approximately $10.6 billion in free cash flow during the first three quarters of 2014, and dividend payments amounted to nearly $7.2 billion. This shows the payouts are financially sustainable, but investors should not expect accelerating dividend growth unless the company can reinvigorate performance.
AT&T's ongoing effort to acquire DIRECTV (NYSE:DTV.DL) is worth watching, as it could open the door for exciting growth opportunities in Latin America. In the meantime, however, dividend growth will most likely remain subdued.
McDonald's has increased its dividend every year since making the first payment in 1976. However, dividend growth has also slowed considerably in recent years, from a 15% increase in 2011 to a hike of only 5% for 2014.
Revenue growth has also lately stagnated or even dropped. November was particularly tough, with comparable sales in the U.S. declining by 4.6% versus the same month in 2013. This revenue challenge is clearly putting material pressure on the company's dividend growth rates.
Competitors in the fast-casual segment, such as Chipotle Mexican Grill (NYSE:CMG), are outperforming McDonald's and stealing its customers, and there is no reason to expect the trend to reverse anytime soon.
McDonald's is simplifying its menu and offering more customization options. Management also plans to change customers' perception regarding the company's products via an increased focus on marketing and communication. While these ideas seem well intended, it's far too early to tell if the company has what it takes to accelerate sales.
McDonald's pays a tasty dividend yield of 3.6%, and the business is financially solid. However, as long as sales are in decline, the worst might be yet to come for investors in McDonald's stock.
Philip Morris International
Philip Morris is a global leader in the tobacco industry; the company benefits from a dominant presence in emerging markets, along with the competitive strengths provided by leading brands such as Marlboro and Parliament.
Philip Morris has raised its dividend every year since 2008, including a 6.4% hike for 2014. The quarterly dividend payment of $1 per share represents a dividend yield of nearly 4.9% at current pricing, an attractive return coming from a financially stable company that produces tons of cash flow on a recurrent basis.
However, investors need to give careful consideration to the long-term risks when investing in tobacco stocks. Smoking rates are declining across the world, and Philip Morris is not immune to the decline: Management anticipated a 2.4% decline in cigarette sales volume during 2014, and it believes global industry volume will decline between 1% and 2% annually for the foreseeable future.
Price increases and cost reductions are buffering the impact from falling sales volume to a considerable degree, but there is only so much the company can do in terms of pricing and cost discipline. As long as industry volume continues on a secular decline, investing in Philip Morris stock can be hazardous to the health of your portfolio.