When it comes to reaching your retirement goals, the easiest path to get from Point A to B is often paved with high-quality dividend stocks.
The importance of high-quality dividend stocks in your portfolio
Although dividend stocks may not be the most glamorous businesses or have the most glamorous growth rates, they're often counted on to do one thing well: make money. In particular, dividend stocks can provide three primary benefits for shareholders.
First, a dividend payment signals to investors that a company is healthfully profitable and has such a positive outlook for its future that it feels comfortable sharing a percentage of its profits with shareholders. Secondly, dividend payments can help offset paper losses experienced during a turbulent or down-trending market. Finally, and most importantly, dividend payments can be reinvested back into more shares of dividend-paying stock, thus compounding future dividends, increasing share price appreciation potential, and likely boosting your wealth.
Of course, simply buying a stock with a high-yield dividend isn't a great strategy on its own. Since yield is a reflection of dividend paid per share and a company's share price, a company whose stock price is falling because its business model is in trouble could sport a high yield that might otherwise seem attractive. Investors need to be willing to look at the puzzle pieces beneath the surface to see if a dividend payment is truly sustainable.
This top Dividend Aristocrat is readying for another dividend hike
One of the top places for income investors to find high-quality dividends is among an elite group of dividend stocks known as Dividend Aristocrats. To be included as a Dividend Aristocrat, a company has to have raised its annual dividend every year for at least 25 years. Currently only around 50 publicly traded companies qualify, or less than 1% of all publicly traded stocks in the United States.
One such company that ranks among the head of the class of this elite group of dividend stocks is healthcare conglomerate Johnson & Johnson (JNJ). Having raised its dividend in each of the past 53 years, Johnson & Johnson is more than likely on track to announce its 54th consecutive increase to its payout in April. You can count on two hands how many publicly traded companies have a longer active streak of increasing their annual payout.
How can I be so confident that Johnson & Johnson can continue to raise its annual payout each year? I'd point to three factors as evidence.
Three reasons why Johnson & Johnson's dividend is likely headed higher
First of all, Johnson & Johnson is sitting on a mountain of cash. Even though the company is carrying about $20 billion in long-term debt, it maintains a AAA credit rating from Standard & Poor's -- one of only three publicly traded companies to carry that badge of honor. This implies the ratings agency has the utmost confidence in J&J to repay its existing debts.
More importantly, Johnson & Johnson has $38.5 billion in cash and cash equivalents, meaning it's toting around $18.5 billion in net cash. Some of this cash very well may be used for acquisitions, as noted by management in its fourth-quarter conference call, but it's very plausible that this cash balance and strong cash flow could coerce growing dividend payments out of J&J.
Secondly, Johnson & Johnson has a reasonably low payout ratio, which would imply that further dividend hikes can be supported. The payout ratio measures what percentage of full-year EPS a company is paying out as a dividend to investors. In the case of J&J, its $0.75/quarter dividend over the past year equates to $3 annually. Compared to its fiscal 2015 EPS of $6.20, this translates into a dividend payout ratio of 48%.
Most profitable powerhouses like J&J prefer to keep their payout ratios between 50% and 60%. Considering that Wall Street expects J&J to report $6.51 in full-year EPS in 2016, a hike just to keep par at 48% (or higher) seems reasonable.
Finally, Johnson & Johnson's business model is suggestive of steady long-term growth. The company, though made up of more than 250 subsidiaries, has three defined operating segments: consumer healthcare, medical devices, and pharmaceuticals.
Consumer healthcare doesn't pack much of a growth punch, but it is responsible for steady cash flow, profits, and pretty strong pricing power. Many of the products J&J supplies will be purchased regardless of whether the U.S. economy is booming or in a recession. In other words, this is J&J's slow, steady, and dependable operating segment.
Next is medical devices, which has been growing a little slower than some shareholders would prefer of late. A very competitive landscape, and an uncertain expenses environment tied to the implementation of the Affordable Care Act, appear to be the culprits holding J&J's device segment at bay for the time being. However, J&J's medical devices have a long-tail growth opportunity as life expectancies increase and access to medical care improves.
Its pharmaceutical segment is where J&J's juiciest profits are made. Recently approved blockbusters like SGLT2-inhibiotr Invokana for type 2 diabetes and Imbruvica for a variety of blood cancers look to carry the load for J&J for years to come. The bulk of J&J's profit margins are generated within its pharmaceutical segment, and J&J is looking to bring up to 10 new blockbusters to market before the end of the decade.
If you're looking for a solid buy-and-hold dividend stock with a yield that's currently beating out the S&P 500, consider giving healthcare giant Johnson & Johnson a closer look.