Investors looking to purchase dividend-paying stocks have hundreds, if not thousands, of options to choose from. However, just because a company pays a dividend doesn’t make it a quality investment. Furthermore, many of the companies that pay dividends pay very small ones and can hardly be counted as quality dividend stocks.
In what follows, I provide investors with three excellent stocks that dividend investors should consider adding to their portfolios. These companies pay large dividends that people can easily afford. Furthermore, they are quality companies that are highly profitable and are leaders in their respective industries. With that being the case, I think they are worth adding to your portfolio on weakness.
1. AT&T (NYSE:T)
AT&T is the highest-paying dividend stock in the Dow Jones Industrial Average. This is more likely a case of mispricing than of weakness. The company pays a 5.2 percent dividend while the S&P 500 pays a paltry 1.9 percent yield. Yet AT&T still trades at just over 10 times earnings, making it one of the least expensive Dow stocks. The company has a very stable business as America’s leading telecommunications provider. While there has been some encroachment by competitors during the mobile era of the past 20 years or so, there is still an extremely high barrier to entry.
Furthermore, switching telecom companies is much more difficult than switching shampoos or coffee brands. While AT&T has been criticized for providing an inferior service, it has been updating its infrastructure in order to improve both its mobile and cable-Internet services. The company is well positioned to finance this while still being able to pay a hefty dividend and repurchasing shares. Going forward, it should continue to be a winner, and it is a great stock to own if you are a retiree or looking for some income.
2. Alliance Resource Partners (NASDAQ:ARLP)
Alliance Resource Partners has bucked the downtrend in the coal industry. While most of its peers are trading at depressed valuations after having taken enormous write-downs, Alliance Resource Partners just reported outstanding earnings, hiked its dividend – as it does every quarter — and is trading at a fresh all-time high. Despite rising 20 percent so far this year, it still trades at less than 13 times earnings, and it pays more than a 5 percent dividend. The key to the company’s success is its low production costs. While the company suffered somewhat with the rest of the coal industry, it also increased production and lowered costs, which has enabled it to continue to hike its dividend without jeopardizing its strong balance sheet. While the stock is due for a pullback, it is one that is worth buying if you can get it at $85-$88 per share.
3. Philip Morris (NYSE:PM)
Philip Morris has had a rough year so far. While the stock is down just 2 percent this year to date, at $85 per share, it traded as low as $75 per share at one point. Furthermore, while the company has had a history of steady profits, it saw its first significant profit decline in the first quarter since going public. Nevertheless, the company has an extremely stable business, and it pays a 4.4 percent dividend. While tobacco may not be a socially responsible investment, there is no denying that people around the world use it.
Furthermore, tobacco is very addictive, and it engenders brand loyalty like few other products. Philip Morris sells Marlboro products outside the United States, and it has the best market positioning in several emerging markets in which we are seeing an increase in tobacco use, such as Russia and Indonesia. While currency weakness in emerging markets has taken a toll on Philip Morris’s profits and revenues, I think this will be a temporary measure.
The company has incredible pricing power, and while emerging market currencies are considered risky, keep in mind that many of these countries have higher interest rates than developed countries, and they don’t have quantitative easing programs that we find in the United States and Japan. Thus, Philip Morris is a great way to get exposure to a stable business that pays a high dividend yield while betting on a weak dollar.
If you’d like to do your own research on which dividend stock to buy, we have you covered. While dividend-paying stocks may seem to be safer, or even better than non-dividend paying stocks, we need to perform due diligence on them all the same. From our earlier article, here are a few tips for picking the winners that will provide you with income for years to come.
1. Know how a company is paying for its dividend
Companies can get the cash to pay dividends from all sorts of sources. Some of these sources indicate that the dividend may not be sustainable or that it is not the product of value creation. There are several companies that have paid dividends by issuing stock or by borrowing money.
For instance one of the most popular dividend paying stocks among income investors is Kinder Morgan Energy Partners LP. If you look at the company’s earnings per share, and then if you look at its dividend payout, you’ll quickly see that in most quarters the company hasn’t made enough money to pay its dividend. For instance in the most recent quarter Kinder Morgan’s EPS came in at $0.67 per share, but it paid $1.38 per share in dividends. The additional money had to come from somewhere. It turns out that the company issued nearly $1 billion worth of debt, and the average number of shares outstanding in the first quarter increased by 8 million versus the prior quarter. This indicates to me that Kinder Morgan’s dividend is not coming from profits. Rather it is coming from capital raises.
On the other hand consider a company such as Microsoft. Microsoft earned $0.78/share in the quarter ended December 31, 2013, but it paid just $0.28/share in dividends. This is a sustainable dividend coming from profits. This is the sort of dividend you should look for when constructing an income portfolio.
2. Bigger isn’t necessarily better
Just because a dividend-paying stock pays a very large dividend doesn’t mean that it is better than one that pays a smaller dividend. When you analyze a company that pays a large dividend, you have to ask yourself not just where the money is coming from, but why the dividend is so large. After all, if a large dividend is such a reliable income source, then why haven’t investors bid up shares of the company so that the dividend yield is smaller?
A large dividend can often mean that investors are uncertain that the company will be able to continue to pay it. Consider, for instance, the mortgage REIT Annaly Capital. This stock paid a dividend of about $0.65 per share every quarter a couple years ago, and yet the stock traded at just $18 per share. This meant that the dividend yield was near 15 percent! But had you bought the stock simply because it paid a high dividend you would have lost money — the stock now trades at $11 per share. Furthermore, the company only pays $0.30 per share now.
Going back to the example of Microsoft, this company has paid a dividend of roughly 2 to 3 percent over the past several years, depending on the share price at a given time. The stock has been steadily rising, and so has the dividend. These two examples show that a small, high quality dividend is superior to a large, low quality dividend.
3. Look for dividend growers
The best dividend companies to own don’t just pay a regular dividend, but they grow their dividends on a regular basis. A company grows its dividend when it grows its profits, and when management believes that this growth is sustainable. Over a long period of time buying companies that grow their dividends can make you a lot of money, even if they are fairly boring companies. For instance a company like Exxon Mobil (NYSE:XOM) isn’t a very fast growing company, but it has been a slow growing company for a long period of time, and it has increased its dividend every year for several decades. Over the past twenty-five years Exxon Mobile has grown its dividend five-fold, and still the company pays a dividend that can be covered several times over by its earnings. This sort of steady long term dividend growth can compound dramatically if you are investing now in order to pay for something in the future such as college tuition or retirement.
Disclosure: Ben Kramer-Miller is long Alliance Resource Partners and Exxon.