We all know the value of investing in dividend stocks. That’s why I was intrigued by StreetAuthority expert Amy Calistri’s unorthodox idea about investing in stocks with low dividend yields.
Her point: Lower-yielding stocks can outperform their higher-yielding counterparts.
Amy’s not saying that all low dividend yield stocks were identical. In fact, she provided a four-step test for screening prospects to determine a stock’s dividend track record, ensuring it had a low payout ratio and high revenue growth, as well as a compelling story for future growth.
I ended up with three stocks I could confidently rate good, better and best. Here’s how I got there.
I was expecting quite a few would survive the first test of paying and increasing dividends, and I wasn’t disappointed. I found 726 possible names on FINVIZ.com, which had a record of at least five years of increasing dividends.
To add my own stamp to the process, I fiddled with the ratings screener. When I moved the rating screen to 3 or better (out of 5), the list shrank to 547 entries. Moving it to the top rating screen of 5 chopped the list to only 10 names. I was in business with a manageable group.
But because I was being picky about only finding top-rated stocks, I decided to add another hurdle before continuing the test. I took the remaining 10 top-rated stocks, matched up “years paying” and “years increasing,” and threw out any company that hadn’t increased each year. Any missteps, and they were out — which was how Caterpillar Inc. (NYSE:CAT) and Monmouth R.E. Inv. Corp. (NYSE:MNR) dropped off the list.
Although I was only looking for companies with five or more years of increasing dividends, the only remaining stocks had been paying for 20 years or more.
Low Payout Ratio
I tossed out any stock that had a payout ratio more than 100%, which was why I bid farewell to Harsco Corporation (NYSE:HSC), Kinder Morgan Inc (NYSE:KMI) and Landauer Inc (NYSE:LDR).
With the first two screens of Amy’s test completed — plus my added criteria of isolating only the highest-rated stocks boasting a perfect record of increasing dividends — I had five contenders: The Clorox Co (NYSE:CLX), Hawaiian Electric Industries, Inc. (NYSE:HE), Kaydon Corporation (NYSE:KDN), Leggett & Platt, Inc. (NYSE:LEG) and Raytheon Company (NYSE:RTN).
For revenue growth, I used the five-year growth rate. A negative five-year revenue growth rate of minus 2.6% eliminated Leggett & Platt, Inc. (NYSE:LEG) despite its positive net income growth rate of 32.9%.
The concept of future growth starts to get into subjective territory, but I decided it was fair to add two more numeric screens to be sure I was looking at the best of the best. First, I screened for net income growth rate over the same period and decided Kaydon Corporation (NYSE:KDN)’s minus 62.3% was a red flag, so my list shrank to three.
My next screen caused no further concern because all three remaining stocks had low price-to-earnings (P/E) ratios.
At this point, I decided to rank the data I had for the remaining stocks for each metric. With one being best, this meant the stock with the lowest total score would be the best.
The final test would determine whether the case for future growth matched up with the ranking.
The Clorox Co (NYSE:CLX) was in the news earlier this year for its worse-than-expected profit decline in its fiscal third quarter and shrinking margins. The company recently said it expects sales growth of 2% to 4% next year, and The Clorox Co (NYSE:CLX) has been trading near its one-year high near $90. I see neither spectacular growth in its future nor a great bargain.
Raytheon Company (NYSE:RTN) recently reported higher second-quarter profits and beat analysts’ EPS estimates. the company also raised its full-year forecasts for this year and next, saying it expects EPS of between $5.51 and $5.61. Like The Clorox Co (NYSE:CLX), Raytheon Company (NYSE:RTN) is trading near its 52-week high, so it’s not a bargain at its current price.