Lessons From Dad: Why Dividends Are So Important
Father's Day is a good time to reflect on lessons passed down from loved ones of previous generations. Here is one from my dad: "My total dividends column is the only one I really care about. The rest are for entertainment."
Let's look at companies that play a role in the daily lives of many dads. We'll leave entertainment noise out and instead examine the main variables to look at to keep a safe and healthy growing total dividend column.
Let's look at some companies that Dad might know a thing or two about:
- Chevron -- Dad needs gas for his car; how else will he get to work?
- Procter & Gamble -- The company owns Gillette, and Dad has to shave every day.
- Coca-Cola -- After a hard day of work, what could be more refreshing?
- Innophos -- I have one word for you: phosphates. (You may not get this one, but trust me, your dad is old enough to remember "The Graduate.")
Next, let's look at the factors that make a good long-term investment.
Ask any dad and they'll tell you not to wander too far out on the branch -- it isn't safe. There's no use in counting on a dividend that's at risk of being cut. Don't believe me? Consider the case of Boardwalk Pipeline Partners.
Dividend cuts are a double whammy. First, your income evaporates and then the shares follow suit. That combination makes for a sad dad. Avoid these dividend cutters.
But how could you have known in advance that Boardwalk's yield was at risk? One way is the payout ratio. Boardwalk's was more than 100% for six years leading up to the cut. That's not sustainable. As Herb Stein observed, anything that can't go on forever won't. Result: Boardwalk cut its dividend and shares were hammered.
Dividend payout ratio is a simple way to ensure your stocks stay on the safe side of the street. As a general rule of thumb, 60% is an upper bar and the "Dad stocks" we've mentioned today have mainly stayed below that.
Innophos' payout ratio has recently spiked up to where it needs to be watched more closely.
Given enough time, quality shows itself. High-quality companies should be able to deliver 15% or better return on equity year in and year out.
As a manufacturer, Innophos makes for a bumpier ride than the rest of the group. Coca-Cola stands head and shoulders above the rest of this group with its more than 25% return on equity.
Now that we have a rough check of dividend safety and overall quality, let's turn to dividend growth. This is where we see the total return column grow.
Dividend Growth Rate
|Procter & Gamble||10%|
These companies' dividends look safe and safe to continue due to the quality of their operations. Better still, this is solid, sustained dividend growth. How many people do you know that received 8%-16% raises every year for the last five years?
OK, but how much is this all gonna cost me?
Dad's been around long enough to know you have to pay a reasonable price for quality. The current P/E ratio for the S&P 500 is 19, which is on the high side. Three of the four companies in our group are priced higher than the market average.
So what should investors do? The historical metrics look reasonable. There are encouraging forward-looking signs -- Coke already does business in 159 countries and is pushing for more international growth, Chevron has massive new projects coming online, Procter & Gamble's new/old leadership, and Innophos is refreshing old plants in Mexico. Which of these companies best meets the goal to protect and grow the total dividend return?
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The article Lessons From Dad: Why Dividends Are So Important originally appeared on Fool.com.Gunnar Peterson owns shares of Chevron, Coca-Cola, and Innophos. The Motley Fool recommends Chevron, Coca-Cola, and Procter & Gamble. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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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