How to pick winning dividend stocks
Statistical studies have proven that investing in dividend stocks can be a powerful strategy for superior returns over the long term. Relying on examples from Apple (NASDAQ:AAPL) and Coca-Cola (NYSE:KO), let's take a look at the key factors to keep in mind when picking the best dividend stocks for your portfolio
Why dividend investing works
Stocks can deliver returns via two different paths: price gains and dividend payments. Price fluctuations are hard to predict, especially in the short term, since they depend on multiple factors related not only to the company's fundamentals, but also to investor sentiment and overall market volatility.
Dividends, on the other hand, are cash payments going directly into your account, and this makes dividends far more stable and predictable than capital gains. For this reason, many investors looking for recurrent income from their portfolios, such as those planning for retirement, tend to put a lot of attention on dividend payments when making investment decisions.
Even more important, dividends say a lot about the health of a business. If a company is going to make consistent cash distributions over the years, the business needs to be solid enough to produce growing sales and cash flows through good and bad times.
According to a research report from Goldman Sachs, dividend stocks tend to outperform their non-dividend paying counterparts by a considerable margin: A $10,000 investment in non-dividend paying stocks in January 31, 1972, would have turned into $30,316 by the end of 2014. The same amount of capital invested in dividend stocks would have turned into a much bigger $461,904 during that period.
Interestingly, companies with consistent dividend growth did even better. A $10,000 investment in companies starting new dividends or raising their payments every year would have turned into a considerably larger $630,024 over the period under study, comfortably beating both companies with stable dividends and those paying no dividends at all.
How to pick winning dividend stocks
It's important to look beyond dividend yield when hunting for the best opportunities among dividend stocks. Investors need evaluate a company's ability to sustain growing dividends over the long term.
Coca-Cola (NYSE:KO) is one of the most renowned dividend stocks in the market, and for good reasons. The company has increased its dividend in each and every year over the last 53 consecutive years, a period that includes all kinds of economic and financial environments. For 2015, Coca-Cola announced an 8% dividend increase, rising annual payments from $1.22 to 1.32. At current prices, Coca-Cola stock is paying a dividend yield of 3.4%, not bad at all coming from such a solid dividend powerhouse.
Coca-Cola's dividends don't come out of thin air, the company owns an enormously valuable portfolio featuring 20 different brands making over $1 billion each in global revenue. This includes not only traditional soda brands such as Coca-Cola, Fanta, Sprite, and Diet Coke, but also names targeted toward health-conscious consumers, like Powerade, Minute Maid, and Dasani.
Superior brand power, abundant financial resources, and a gargantuan global distribution network make Coca-Cola an undisputed leader in nonalcoholic drinks, and management knows how to translate those strengths into growing dividends for investors.
Apple has both the competitive differentiation and more than enough financial strength to continue paying growing dividends over years to come. (Photo: Jon Swartz, for USA TODAY)
Apple is the most valuable brand in the world according to Interbrand, with an estimated brand value of over $170 billion. Brand recognition and a reputation for quality allow Apple to charge premium prices for its products and generate superior profitability for investors. The business brought in nearly $69.8 billion in free cash flow during the year ended in September, and the company allocated $11.6 billion to dividend payments over that period.
Apple pays a modest dividend yield of only 1.8%, and the company reinstated its dividends in 2012, so it doesn't have the same pristine trajectory of dividend growth as Coca-Cola. On the other hand, the company has both the competitive differentiation and more than enough financial strength to continue paying growing dividends over years to come, and this is a huge positive for investors in Apple.
Successful dividend investing is about much more than simply picking companies with big dividend yields. You need to analyze the sustainability of those dividends and the potential for future dividend growth. While numbers and financial metrics are undeniably important, qualitative factors such as brand differentiation can make a big difference for investors over time.