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).
Revenue Growth
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.
Future Growth
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.
With a market cap of $2.6 billion, Hawaiian Electric Industries, Inc. (NYSE:HE) is the smallest company of the group. It’s also much less diversified, with its fortunes tied, not surprisingly, to those of Hawaii. The company supplies 95% of the islands’ electricity through its electrical utilities division, which accounts for about two-thirds of Hawaiian Electric Industries, Inc. (NYSE:HE)’s revenue. Hawaiian Electric Industries, Inc. (NYSE:HE)’s banking division — which is one of the state’s largest and accounts for the remaining third of the company’s revenue — has dramatically expanded its mortgage business and reported higher net income in its most recent quarter. The stock is currently a bargain as it’s trading near the midpoint of its 52-week range.
Risks to Consider: Companies can change their dividend policies at any time, and it bears repeating that past performance is not an indication of future results. Both Raytheon Company (NYSE:RTN) and Hawaiian Electric are heavily dependent on single sectors, defense for Raytheon and the Hawaiian economy for Hawaiian Electric. Hawaiian Electric will also likely move in response to its Aug. 8 earnings report.
Action to Take –> Between Raytheon Company (NYSE:RTN) and Hawaiian Electric Industries, Inc. (NYSE:HE), I think I give the edge to Hawaiian Electric for its higher revenue growth and dividend yield. Hawaiian Electric Industries, Inc. (NYSE:HE) also provides a relative bargain entry point, trading now at $27 compared with its 52-week high near $29. In Raytheon Company (NYSE:RTN)’s favor, I don’t see the defense sector shrinking, but with the number of retiring baby boomers on the rise, Hawaii is primed to continue to be a growth region. Plus, imagine the fun of going to visit your “investment.”
P.S. — This is just the start to one of the most effective dividend strategies around. “The Dividend Trifecta.” Simply put, it’s a three-part approach to dividends that multiplies the effectiveness of every dollar you invest. The plan is specifically engineered for people who want to retire sooner or for those who would like to get a steady stream of extra income now. Go here to learn more…
– Bristol Voss
The article 3 Income Stocks That Passed Our ‘2-Minute Test’ originally appeared on StreetAuthority and is written by Bristol Voss.
Bristol Voss does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
