There's only one thing I love more than a dividend stock -- a dividend stock with growth potential. There are a whole lot of companies out there flaunting oversized dividends and tales of grandeur with nothing to back them up. Let's take a closer look to see what companies can truly pull profits for your portfolio in 2013.
Look to the past
We don't do it enough, but a simple look in the rearview mirror offers investors unique insight into whether management values dividend growth. Here's how five utilities' dividends have fared over the past five years:
Atlantic Power surged to the lead in the past year, but it doesn't have the track record to back it up. Founded in 2004, the utility initiated a dividend for the first time in 2010 and adheres to a monthly distribution schedule. National Grid is a bit of an oddball, since a 2010 stock slump and steadfast dividend payout resulted in a record 16.8% yield. Since then, things have cooled down and the utility's back to a more reasonable 5.9% yield. Southern Company and Consolidated Edison have contracted slightly over time, while Exelon offers the only steady positive trajectory of any stock listed here.
Sustainability is king
Looking to the past shows us whether a company has grown its dividend over time, but it doesn't answer the equally important question: Can a company afford to keep doling out bigger dividends to shareholders? It's easy to get greedy over quarterly (or monthly) payouts, but dividends are just one tool for companies to return value to shareholders.
Utilities are capital intensive companies, and are constantly balancing capital expenditures with dividend payouts. Examining a utility's payout ratio (dividends paid as a percentage of net income) is fairly useless, since net income is not much more than an accounting gimmick for companies that rely on deferred costs, depreciation, amortization, and other tools to smooth out their monetary mayhem.
Instead, calculating how much of a company's free cash gets sectioned off for dividends can tell us a lot about a dividend's staying power.
Elephant in the room: In the same way that National Grid's yield skyrocketed when its stock price dropped, Southern Company's 2011 dip into negative cash flow temporarily blasted its steadfast dividend into unsustainable territory. Today, the company enjoys positive cash flow, but is paying out 850 times its cash on hand to keep its dividend at 4.4%. Southern Company has spent over $4 billion in capital expenditures each year since 2009 as it ramps up its nuclear efforts and builds "clean coal" generation facilities, but it's stretching its finances a bit too thin for my liking.
Cash Dividend Payout Ratio
Source: YCharts, e*trade, and author's calculations
Exelon, National Grid, and Con Ed all have positive cash flows and are paying out more than 90% of their cash in dividends, but they're not scrimping on self-investment. Any ratio near or above 100% is cause for long-term concern, but these companies can manage for now as they appease investors looking for steadier income.
Finally, Atlantic Power may be biting off more than it can chew. With less than 10 years to its name and the heaviest capital expenditures around, it seems this utility's got a whole lot more it can do with investors' money than return it to shareholders every month. Instead of issuing relatively high interest debt to fund its growth-by-acquisition strategy, Atlantic should be making moves with investor's money.
As the nation moves increasingly toward clean energy, one company in this space that is perfectly positioned to capitalize on having the largest nuclear fleet in North America is Exelon. This strength combined with an increased focus on renewable energy, along with its recent merger with Constellation, puts Exelon and its best-in-class dividend on a short list of top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.
The article Will These 5 Dividend Stocks Soar or Stumble in 2013? originally appeared on Fool.com.
Justin Loiseau has no position in any stocks mentioned, but he does use electricity. You can follow him on Twitter, @TMFJLo, and on Motley Fool CAPS, @TMFJLo.The Motley Fool recommends Exelon Corp, National Grid plc (ADR), and Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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