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10 bets on pumped-up dividends
A longtime money manager looks for stocks with a long record of hefty dividend increases. Big banks, manufacturing plays make the list.
By Michael Brush
Shopping for stocks with solid dividends is in style these days as investors look for ways to boost returns in what's expected to be a ho-hum market in 2005.
But a relatively new fund run by Eastern Point Advisors, a division of Investors Capital Holdings (ICH, news, msgs), adds an intriguing twist to the dividend hunt. It looks for companies with dividends on steroids.
Managers at the fund won't even consider investing in a company unless it has been hiking dividends by at least 10% a year for 10 years.
Does this strategy really help you beat the market? Past results don't predict future returns, as the clich goes, but the short answer is yes -- and how. Back-testing by Eastern Point Advisors shows this approach would've produced gains of 2,739% since 1970 (as of last week), compared to gains of 1,301% for the Standard & Poor's 500 ($INX) over the same period. Put another way, overachievers in the dividend department grew 14.3% per year vs. 11.1% for the S&P 500.
"I have been using the philosophy since early 1970s. I know it works," says Tom Cameron, who manages the Eastern Point Advisors Rising Dividend Growth Fund (ICRDX), launched last March to implement the dividend strategy.
Why would this approach pay off? Partly because rising dividends, by nature, lead you to companies with solid growth, says Cameron.
"Stocks go up when earnings go up, and dividends never go up unless earnings go up," says Cameron. What's more, companies paying a dividend usually, but not always, have fairly solid financials and cash flow.
Cameron's screens for companies with dividends on steroids typically net only about 160 names. From there, Cameron, who's still managing money at 77, applies basic fundamental research to come up with the best candidates. I asked him for the cream of the crop. Here are his favorite 10 picks, along with some commentary by analysts from Morningstar and brokerage firms.
| 10 bets on rising dividends | | Company sector and name | Recent price | Average dividend increase* | Annual dividend | Dividend yield | | Four banks | | | | | | Bank of America (BAC, news, msgs) | 44.5 | 13.90% | 1.8 | 3.99% | | Citigroup (C, news, msgs) | 47.6 | 31% | 1.6 | 3.33% | | Doral Financial (DRL, news, msgs) | 48.7 | 28.21% | 0.72 | 1.48% | | Glacier Bancorp (GBCI, news, msgs) | 31.5 | 14.70% | 0.68 | 2.10% | | Three manufacturing plays | | | | | | Caterpillar (CAT, news, msgs) | 92.8 | 27% | 1.64 | 1.78% | | Franklin Electric (FELE, news, msgs) | 40.9 | 15% | 0.32 | 0.78% | | Roper Industries (ROP, news, msgs) | 59.0 | 22.70% | 0.425 | 0.72% | | Three master limited partnerships | | | | | | Enterprise Products Partners (EPD, news, msgs) | 26.6 | 9%** | 1.58 | 5.93% | | Kinder Morgan Energy Partners (KMP, news, msgs) | 45.4 | 17% | 2.92 | 6.45% | | Magellan Midstream Partners (MMP, news, msgs) | 61.3 | 17.7%*** | 3.56 | 5.82% |
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*per year, compounded annually over the last 10 years
**average annual increase for past five years
***average annual increase for past three years
Cross country
- Bank of America (BAC, news, msgs): With a coast-to-coast branch network that gives it 80% more locations than its nearest rival, Bank of America is the closest thing we have to a nationwide bank, says Morningstar analyst Craig Woker.
What's more, the bank is the dominant player in some of the fastest growing regions. And it's made a solid effort to go after fast-growing demographic groups, like Hispanics in Texas and California, says Cameron. The stock looks cheap, he says, with a forward price-to-earnings ratio of 11, a discount to the S&P 500.
While Woker has doubts about purported benefits from Bank of America's recent acquisition of FleetBoston Financial, he thinks the bank will still produce "some of the strongest profits in the banking industry." That's one reason Woker thinks the stock, at $44.50, trades nearly $4 below where it should be.
- Citigroup (C, news, msgs): The world's largest bank, Citigroup has a highly diversified collection of businesses that span the globe, from credit cards and retail banking, to investment banking and asset management. This is one reason the bank continued to perform fairly well when the U.S. economy slumped, says Woker.
Despite its strengths, Citigroup trades at just 11 times expected earnings, pulled down in part by bad press sparked by purported wrongdoing in a Japanese division and at its London bond-trading desk. Despite these black eyes, Cameron cites management integrity as one of the main reasons he likes this bank.
Woker puts fair value for the stock at $54, or $6 above where it now trades.
Going against the convention
- Doral Financial (DRL, news, msgs): It's a mortgage lending and retail bank in Puerto Rico, and one of Cameron's more controversial picks. Yes, it's performed like gangbusters in recent years, thanks to a booming mortgage business. Profits from mortgage sales increased an average of 50% a year between 1999 and 2003. And Doral has hiked its dividend an impressive 28% per year on average in the past decade.
But Morningstar analyst Ryan Batchelor worries that mortgage growth will slow as interest rates rise, one reason he puts the bank's fair value at $45, or nearly $4 below where it trades.
Cameron, however, isn't too troubled by rising interest rates. He points out that Puerto Rico has a chronic housing shortage and a powerful culture of home ownership. Both should support demand for homes and mortgages even if interest rates climb, he says.
- Glacier Bancorp (GBCI, news, msgs): Glacier Bancorp is a mid-size regional bank with divisions in Montana, Idaho and Wyoming. With a $775 million market capitalization, it's fairly small, but Glacier has sizable growth ahead for two reasons.
First, many of the regions it serves are seeing population growth, says Cameron. Second, the bank has a good record for making savvy acquisitions, and more are on the way, says Ben Crabtree, an analyst who covers the bank for Piper Jaffray. He has a $36 price target on the stock, which trades around $31.50.
More than a name on a cap
- Caterpillar (CAT, news, msgs): It's the world's largest maker of construction equipment, with nearly double the sales of its closest rival. The company makes everything from earthmoving equipment and tractors to trucks, paving equipment, log loaders and engines.
Cameron sees this company as a play on rising commodity prices and growth in China. "If the demand for commodities is going up as it is, who is digging all the new mines and fixing the roads to get that done? Caterpillar is right in there," says Cameron.
Despite a 20% increase in the stock since August, Caterpillar still looks fairly cheap, trading at 13 times forward earnings, says Cameron.
- Roper Industries (ROP, news, msgs): It sells testing, metering and imaging equipment used by companies making a wide range of products, from semiconductors and cars to oil and gas. Roper products are also used in water services, power generation and health care.
Roper generates solid cash flow, which helps explains why the company will continue to grow through acquisitions, according to James Lucas, who follows the stock for Janney Montgomery Scott.
- Franklin Electric (FELE, news, msgs): It sells electric motors used underwater to pump fuel, water and other liquids. The company is also a commodities play of sorts, since its motors are used in offshore drilling and mining. With a forward price earnings ratio of 20 and a projected growth rate of 10% per year, Franklin is one of pricier stocks on Cameron's list.
Complicated but profitable
As I explained in a column on master limited partnerships in February, these high-yield investing vehicles can be a real pain around tax time.
On the other hand, they're designed to pay dividends in the 6% to 8% range. So if you're looking for income plays, they're a great way to go. Under the partnership agreements that set them up, master limited partnerships (MLPs) give investors most of their cash flow in quarterly distributions.
Cameron likes the two biggest master limited partnerships in the energy sector: Kinder Morgan Energy Partners (KMP, news, msgs) and Enterprise Products Partners (EPD, news, msgs). He also likes one that was spun out of financially troubled Williams (WMB, news, msgs) to raise funds, Magellan Midstream Partners (MMP, news, msgs). To have more high-yield MLPs to chose from, Cameron relaxes his rule demanding a 10-year track record on dividends for MLPs. This way he can consider the ones that have been around for less than 10 years, like Magellan and Enterprise Products.
All three of these are in the energy pipeline and transport business. This is a relatively safe area because their fees are fairly predictable, since they're set by regulators. Plus these master limited partnerships charge for simply moving oil and gas around, so price fluctuations of those commodities don't matter much.
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