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Growth-stock investors often look down their noses at dividends, which they consider a sign of a business that is past its prime. We don't agree. Buying stocks that pay a steadily rising dividend has long been a growth-stock strategy, and, we think, a good one.
We believe investors willing to venture back into the post-crash stock market should put dividend-raising stocks high on their list. A lot of great ones are selling at deeply discounted prices right now. In fact, dividend raisers offer the best of two worlds. These companies usually have steadily rising profits and prospects for more of the same. Plus, they offer a small measure of stability in these tumultuous times. Executives of these firms know their investors expect annual raises and that providing them is job one. "I view dividend payments as a long-term commitment by management," says David Ginther, manager of Ivy Dividend Opportunities fund.
Unfortunately, dividend-investing strategies have taken a hit lately because of turmoil in the financial sector. Banks and other financial companies have been the backbone of many dividend-investing strategies, accounting for about a fifth of all dividends paid out by companies in Standard & Poor's 500-stock index. But many financial companies, including Citigroup and Bank of America, have responded to their industry's well-publicized troubles by reducing their payouts.
While some dividend-stock indexes have taken a big hit this year, dividend-raising stocks have more than held their own. The S&P 500 Dividend Aristocrats index, a collection of companies that have consistently raised dividend payments for 25 years or more, is down 27% this year, far less than the 38% loss of the S&P 500 overall.
With that in mind, we looked around for attractively priced dividend payers that, despite the recent turmoil, still look like good bets to continue rewarding shareholders with rising payouts. These five fit the bill.
Transformed cash cow
IBM has been paying dividends since 1913, but lately Big Blue has been raising them at an attention-getting rate. In the past five years the payout has risen by more than 20% annually, and since 2006 it has nearly doubled, to $2 a share. How can a company with revenues growing by a modest 3% to 4% or so a year produce these outsize dividend gains?
IBM's global business generates immense amounts of cash -- $70 billion in the past five years and $17.4 billion in 2007 alone. Some of that money has been used to retool IBM's business and make it more profitable. Since 2003, the company has shed its slow-growing businesses, such as PCs and disk drives, and acquired more than 60 higher-growth firms, many of them in software and business services. As a result, its pretax profit margin has risen significantly, to 14.7% last year from 10.6% in 2003.
The Armonk, N.Y., company is also using its cash -- and $11.5 billion in borrowed funds -- to buy back its stock, increasing the earning power of the shares that remain. Last year, it spent $19 billion on share repurchases, reducing the total outstanding by about 7%. For 2008, it expects to spend another $12 billion to repurchase shares. Don't worry. There's plenty left over for dividends. Last year, the $2.1 billion IBM paid out was a small portion of its $10.4 billion in net income.
Can IBM keep it up? We think so. The company offered one of the market's few glimmers of hope in October when it said third-quarter net income would come in 20% higher than a year ago. The company's business is well diversified. It operates in 170 countries and gets two-thirds of its revenues outside of the U.S. About half of those revenues come from long-term service contracts. That helps make its earnings stable and predictable. At $88 a share, the stock (symbol IBM) sells at a reasonable nine times expected 2009 earnings of $9.42 per share, up from estimated 2008 profits of $8.73 per share (all prices are to October 13).
Play for the long run
Sportswear giant Nike is a relative newcomer to the dividend-raisers team. Since 2003, it has boosted its payout by 27% annually, to a current rate of 92 cents a share. With the company's ubiquitous swoosh logo turning up in more places around the world, the dividend gains should keep coming.
Nike is the sportswear market leader in the U.S. (with a 36% share, compared with 21% for Adidas) and China, which is now Nike's second-largest market. About two-thirds of Nike's sales are outside the U.S., helping to blunt the impact of the softening domestic economy. Last year, sales rose 9% globally (excluding currency gains), despite just 4% growth in the U.S. Sales increased in every geographic market and in each of Nike's business segments. A strengthening dollar (which makes exports more expensive for foreign buyers) and slowing foreign economies could become a drag on international sales.
Even so, we think Nike can harness its size and financial strength to keep profits growing steadily for a long time. Like IBM, Nike continues to fine-tune its mix of businesses. For example, it sold Starter, a maker of inexpensive sneakers and athletic clothing, and added Umbro, which has cachet among soccer aficionados. Nike is also using its hefty cash flow to pay dividends and repurchase shares (it bought back $1.2 billion worth during the fiscal year that ended last May). The Beaverton, Ore., company's balance sheet is in great shape, with little debt and nearly $3 billion in cash and short-term investments.
At $55, the shares (NKE) are 23% below their March peak of $71. They trade at 14 times expected earnings of $4.01 for the fiscal year that ends next MayQa reasonable though not rock-bottom valuation for a solid and growing business.
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