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Dividends4Life (31.07)

Characteristics of Great Dividend Growth Stocks

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April 24, 2013 – Comments (1) | RELATED TICKERS: PG , KO , PEP

What makes a great dividend stock? Investors in dividend growth stocks are looking for stocks that will increase their dividend each and every year at a rate that makes the stock a better investment than fixed income alternatives on a risk adjusted basis. I have found that stocks that are able to do this share some common characteristics. They include...

Brand Recognition/Low Price

During an economic downturn consumers may flee many popular brands if their cost is high and generic alternatives are substantially cheaper. Procter & Gamble Co. (PG) saw this occur in some of their premium brands like Pampers and Tide. However, most people aren't willing to save a few pennies on a generic soda of unknown quality when a Coca Cola Co. (KO) or Pepsico Inc. (PEP) is available.

Value-Priced Convenience

In addition to Brand Recognition/Low Price some companies also provide convenience. If you have been out shopping all day and are tired, you are likely to stop on the way home and pick up something that is quick and inexpensive. There seems to be a McDonald's (MCD) on every corner. A stop there provides the guest with a known commodity - clean restrooms, quick service and an inexpensive meal.

A Superior Operating Model

How do you compete with a company like Wal-Mart (WMT)? As most of their competitors have learned, you can't beat WMT at providing brand name, quality merchandise at rock bottom prices. During the good times, some people don't mind paying premium prices at an upscale store, but there are plenty of us value conscious people that keeps WMT humming. Where WMT really shines is during an economic downturn. When losing your job is a real option, $120 sneakers just don't quite seem as important as they once were.

A Pseudo Monopoly

If you are the only company in the world that is allowed to sell a product that people's lives depend on, you will likely have a robust profit margin. This is the world that pharmaceutical companies operate in. Granted companies like AbbVie Inc. (ABBV) and Bristol-Myers Squibb Company (BMY) have to keep coming up with new products as old patents expire, and have to deal with government regulation, but the good ones not only survive, they thrive.

Sell What People Want and Need

Sounds simple, but so few companies have mastered it. Consumer staples seem to be the best at it. When you consider the longevity of Johnson & Johnson's (JNJ) products such as Band-Aid, Johnson Baby Products, Listerine, Tylenol, Motrin, Benadryl and many others, it is easy to conclude that the company has identified what people want/need and are providing it at a reasonable cost.

They Got a Name for the Winners in the World

Just as in life, companies that are winners separate themselves from the others. They won't settle for second best, instead they continue to look for advantages that will them keep a few steps ahead of the competition. Warren Buffet would describe many of the above advantages as wide moats. If you want to buy and hold a stock forever, make sure it has a competitive advantage that is not easily duplicated.

Full Disclosure: Long PG, KO, PEP, MCD, WMT, ABBV, JNJ. See a list of all my dividend growth holdings here.

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1 Comments – Post Your Own

#1) On April 24, 2013 at 11:22 AM, JohnCLeven (80.86) wrote:

Thanks for the post!

Dividend growth is really amazing. If you own a great company, for a long long time, you can eventually get dividend yields on cost in the 8%-10% range. The dividends itself could beat the market without any appreciation in the stock. When you get to that point you can basically hold forever and beat the market easily.

I think part of the key is going with simple businesses that have the highest probability of growing earnings and cash flows for the next two or more decades. A company cannot grow dividends faster than they grow earnings forever.

To me, it comes down to finding and buying: 1) wide moat companies, that are 2) virtually guaranteed to grow earnings and cash flows at high single digit or higher growth compounded annual rates for decades to come, 3) have history of shareholder friendliness, 4) can be bought for a fair to cheap purchase price, 5) and then almost never selling them.

 

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