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Why More Stocks are Likely to Pay Dividends

The growing number of Americans approaching or at retirement age is increasing interest in dividend stocks.

By Chloe Lutts


A few months ago, we surveyed you, our Investment of the Week readers, and asked what types of investments you wanted to read about. Small company stocks, technology stocks and oil and gas stocks were all popular choices. However, the investment class with the most votes by far, with 69% of readers expressing interest in it, was dividend-paying stocks.

The subscribers to my Dick Davis Dividend Digest were among those surveyed, and they’re obviously interested in income-generating investments. However, they represented far less than 69% of the sample, leading me to conclude this is a topic of broad interest among you.

One of the likely reasons for high interest in dividend payers is the increasing number of Americans—and my readers—approaching or at retirement age. Owning dividend-paying stocks is a great way to keep receiving regular income after you retire. Consequently, I suspect that these investments will only increase in popularity as the baby boomer generation retires. Those of you already invested in dividend payers will benefit as their increasing popularity drives up prices. And investors looking to add an income component to their portfolios will probably see even more options in coming years, as demand drives younger blue chip-type stocks like Cisco (CSCO) to introduce dividends for the first time. I also expect some companies that currently pay only small dividends to increase their payouts to attract more retiree investors.

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Of course, there are already plenty of great dividend payers out there. The most reliable are the S&P 500 Dividend Aristocrats: Companies that have increased their dividends for at least 25 consecutive years. Typically, a so-called Dividend Aristocrat is, by its very nature, a large and relatively stable blue-chip company with a healthy balance sheet. A Dividend Aristocrat is considered the “gold standard” for dividend-generating stocks and, as such, income investors seek them out. A lot of companies, particularly financials, fell off this hallowed list in 2008 and 2009, so the ones left are truly the crème de la crème of dividend payers. Many of them are featured in the Dividend Digest regularly.

Today, I’d like to share a few of the most recent recommendations from the list. They’re all great options for investors looking to create or add to an income-generating portfolio:

Insurer and Dividend Aristocrat The Chubb Corporation (CB) was originally recommended in the Dividend Digest over a year ago, on February 10, 2010, at 48.40 by John Eade of the Argus Weekly Staff Report. At that time, he wrote: “We expect a well-managed combined loss and expense ratio and an aggressive stock buyback program to drive results, as the top line takes a couple more quarters to revive. The company’s balance sheet is in solid shape, with industry-low debt levels. CB shares are now trading at near parity to book value, which is historically an attractive valuation.”

In a follow-up published in the Dividend Digest almost exactly a year later, on February 9, 2011, Eade wrote: “We are maintaining our BUY rating and $65 target price on Focus List selection The Chubb Corp. Chubb is doing a good job managing what it can control—the noncatastrophe combined loss and expense ratio— and its aggressive stock buyback program is also driving results.”

In February 2011, CB was trading around 59. It has since crept up a bit to 62, and on March 16 it paid a 39-cent dividend, its highest ever. Think insurance companies are boring? Think again. Well-managed insurers can be insanely profitable—and they produce most of their profits by investing customers’ premiums themselves, often in income-generating securities. That’s why owning top-quality insurance stocks like CB is a great way to generate reliable and growing income.

Exxon Mobil (XOM) is the S&P 500 Dividend Aristocrat Index’s seventh-largest constituent by market cap. XOM’s performance has been nothing less than stellar over the last six months. It was last recommended in the Dividend Digest on January 12, 2011, when it was selected as a Top Pick for 2011 by Stephen Todd, Editor of the Todd Market Forecast. He wrote:

“The stock’s current yield is 2.3%, and the appreciation potential should be excellent. This is because 2011 is likely to see an economic growth spurt and the Obama Administration seems anti-oil. This will prevent drilling at a time when demand increases. The rise in oil prices should be a boon to ExxonMobil.”

Four months later, oil prices have indeed risen, and XOM is 14% higher, trading around 85. The yield has fallen closer to 2% thanks to the price increase, but Exxon usually increases its dividend for the second quarter, which will be paid in May.

Abbott Laboratories (ABT)
is definitely an income investor favorite; I see it recommended by one of our contributors at least once every month. Ingrid Hendershot, CFA, editor of Hendershot Investments, also chose it for the January Top Picks issue. She wrote:

“Abbott Laboratories (ABT 47.86 NYSE – yield 3.70%) is a global, broad-based health care company. Abbott’s primary businesses include pharmaceuticals, with key therapeutic areas including immunology, cardiology and infectious diseases; nutritional products for infants, children and adults with special dietary needs; and medical products, including vascular, laboratory and molecular diagnostics, vision care and diabetes. The company markets its products in more than 130 countries. Abbott is expanding its overseas presence, most recently with the acquisition of Piramal Healthcare Solutions, one of the biggest generic pharmaceutical suppliers in India.

“Abbott generates strong cash flow from its operations. Free cash flow has more than doubled from $3 billion in 2004 to over $6 billion in 2009. Free cash flow through the first nine months of 2010 increased 24% to $5.7 billion. The company returned $2.9 billion of the cash to shareholders in the form of $2 billion in dividends and $866 million in share repurchases. The dividend currently yields an attractive 3.7%. Abbott has paid a dividend every year since 1924 and increased the dividend for 38 consecutive years. With market leadership positions across multiple growth areas, a strong financial position, record cash flows and highly profitable operations, Abbott is a HI-quality company. With an expected 13% free cash flow yield, Abbott is attractively valued and well-positioned to continue to increase its dividend thanks to its bountiful cash flows. Long-term investors should consider injecting Abbott into their portfolio for healthy long-term total returns.”

Abbot just increased its dividend, to be paid May 16, to 48 cents, giving it a yield of 3.80% at today’s price of 50. As Top Picks, the Abbott and Exxon recommendations will both be updated in this summer’s special issue of Dividend Digest Top Picks Update.

Johnson & Johnson (JNJ)
is another popular recommendation among Dividend Digest contributors. Mark Deschaine, editor of Deschaine & Company’s Viewpoint, was the last expert to recommend it in the Digest on October 10, 2010. He wrote:

“Johnson & Johnson may seem out of fashion in today’s frivolous, hyperactive, and alpha-starved investment environment; but this $170 billion dollar health care and personal product empire has been a wealth creating, income producing, compounding machine for well over a century. … Johnson & Johnson makes and markets thousands of diverse health care and personal care products, including such household medicine cabinet staples as Tylenol and Listerine, as well as some of the world’s most sophisticated medical devices and diagnostic equipment. JNJ has been paying a dividend since 1944 and has increased it annually for over 47 years. … For every share you might have bought in 1979 at $0.85, you would now be receiving $2.16 in annual dividends, or more than 2.5 times your initial investment—each and every year— and growing to boot! Going forward, you can be sure we do not anticipate this kind of supercharged income growth. However, our analysis indicates that Johnson & Johnson should be able to continue to generate positive cash flow from its stable of products and continue to pay and increase its dividends for years to come. As long as that’s the case, and the price of the stock remains reasonable by our valuation measures; we’ll continue utilizing the dividend and dividend growth attributes of JNJ to provide growing income to our clients.”

At today’s price near 59, JNJ is currently yielding 3.63%.

Most recently, Patrick McKeough, editor of the Wall Street Stock Forecaster, recommended Dividend Aristocrat The McGraw-Hill Companies (MHP) in the March 9, 2011, Dividend Digest. He wrote:

“McGraw-Hill gets 70% of its earnings and 45% of its revenue from its Standard & Poor’s division, which provides financial information, including credit ratings on bonds. The company also publishes textbooks and magazines, and owns nine television stations. In 2010, McGraw-Hill’s revenue rose 3.6%, to $6.2 billion from $6.0 billion. Revenue from Standard & Poor’s rose 8.3%, as businesses took advantage of low interest rates to issue more bonds. The textbook division’s revenue rose 1.9%, thanks to higher college enrollment and rising demand for electronic versions of its books. That offset slower demand for new elementary and high school textbooks. Revenue at McGraw-Hill’s media operations fell 4.9%, mainly because the company sold BusinessWeek magazine in 2009. Without this sale, this division’s revenue would have risen 6.2%.

“Earnings rose 13.2% in 2010, to $840.0 million, or $2.69 a share. The company earned $742.2 million, or $2.37 a share, in 2009. These figures exclude gains on the sale of BusinessWeek and other assets, as well costs to restructure the textbook and media businesses. McGraw-Hill continues to buy related companies. It recently paid roughly $300 million for, a privately held firm that sells investment research and data to hedge funds and other institutional investors. The company can easily afford to keep making purchases like this. Its long-term debt of $1.2 billion is just 10% of its market cap, and it holds cash of $1.5 billion, or $4.97 a share. Continued falling demand for elementary and high school textbooks could hold back McGraw-Hill’s earnings growth in 2011. Still, the stock trades at a reasonable 13.3 times the company’s likely 2011 earnings of $2.85 a share. McGraw-Hill also raised its quarterly dividend for the 38th consecutive year, to $0.25 a share, up 6.4% from $0.235. The new annual rate of $1.00 yields 2.6%. McGraw-Hill is a buy.”

To learn more about Dividend Aristocrats like CB, XOM, ABT, JNJ and MHP, check out Dick Davis Dividend Digest, where top income-generating stocks are recommended each and every month. Learn more here.

Wishing you success in your investing and beyond,

Chloe Lutts
Editor of Investment of the Week

Cabot Editor