The S&P500 has gone nowhere since mid-February as investors start to wonder how much farther the bull can run.
Fears over geopolitical issues, weakening expectations for earnings and the economy, and doubts on tax reform have all put investors on edge. The VIX volatility index, also known as the “Fear Gauge,” jumped 29% to 15.9 over the first two weeks of April to reach its highest point this year.
[ad#Google Adsense 336×280-IA]A total of 527 companies cut their dividend payments at the height of the financial crisis in 2009 and only the most stalwart dividend-payers survived.
Even bellwether names like General Electric, Dow Chemical, and JP Morgan cut their payments to investors.
Protecting your portfolio from falling stock prices and dividend cuts today means finding companies with sustainable dividends from strong cash flows and a best-of-breed brand.
When looking for sustainable dividend stocks, I use four fundamental factors to find the companies with the commitment and cash flow to keep putting money in my pocket.
Seeking Sustainable Dividends Against Market Stress
First-quarter earnings are slowly starting to come in and the results are a mixed bag. The S&P 500 closed flat last week as investors started to question high valuations. The bears may finally get their market correction if companies can’t beat expectations and provide positive guidance for the rest of the year.
On the economic side, Morningstar’s chief economist Bob Johnson believes the first quarter is set to disappoint and that the rest of the year could face hurdles. Retail sales and industrial production for March were a surprise disappointment and showed the economy may be weakening into the second quarter.
The GDPNow estimate of economic growth by the Atlanta Fed started the year at 2.3% before hitting a high of 2.5% in February, but is now estimating growth of just 0.5% for the first quarter.
Against the potential for a correction in the stock market or worse, investors need to start thinking about sustainability in the dividend payments for their picks. Finding companies with sustainable dividends comes down to a handful of fundamental factors such as cash flow, debt coverage, the payout ratio, and management’s commitment to the dividend.
First, I look for companies with at least three consecutive years of increasing cash flow from operations. Companies can raise cash from financing or by selling long-term investments but that’s not a sustainable source of cash. I want to see strong cash generation directly from the business.
Runaway debt can crush a dividend faster than anything, especially in industries where the growth model is to acquire other companies and run up huge long-term liabilities. Watch the EBITDA-to-interest coverage ratio closely to make sure your dividend-payer is making more than enough money to service its debt obligations.
I want to know that management is committed to returning cash to shareholders and there’s no better way to measure this than the 5-year dividend growth rate. On strong economic growth over the last five years, I want to see companies increasing their dividends by 10% or more on an annualized basis.
Finally, if a company gets into trouble and income drops significantly, the dividend could be the first to go. Watch for companies that pay out less than half their income in dividends to make sure your dividend picks have a sizeable financial cushion.
3 Industry Leaders That Can Survive And Thrive
In any financial downturn, the best-of-breed companies will be able to retrench and even steal market share from lower-quality brand names. Leaders in their industries will be able to protect cash flows and their dividends.
Amgen Inc (Nasdaq: AMGN) has booked the highest dividend growth rate and yield of my three favorite sustainable payers. The company is a leader in the biotech space and has invested heavily in manufacturing efficiency to boost margins.
The company’s acquisition of deCODE Genetics gives it industry-leading technology to identify and validate disease targets for drug development. Amgen’s pipeline has struggled for several years but its new cholesterol drug Repatha and upcoming launches for osteoporosis and migraine treatments could prove blockbusters. If these drugs are successful, they could make Amgen one of the best long-term dividend stocks to buy now.
Shares have been under pressure on drug pricing headlines but should benefit from stronger revenue and expectations of 5.9% earnings growth this year. Shares trade for just 13.8 times trailing versus a five-year average of 18.6 times earnings.
CVS Health (NYSE: CVS) has an unmatched distribution model in healthcare with its pharmacy benefits manager (PBM) and the largest retail pharmacy chain in the United States. The company fills more than 1.3 billion prescriptions annually, giving it negotiating power over drug manufacturers and scale over other retail operations.
I recently highlighted CVS as one of the best Blue Chip Stocks for 2017 on recent valuation and its leadership in healthcare. Free cash flow of more than $9 billion last year allowed the company to return $6.3 billion to investors through share repurchases and a 2.5% dividend yield.
Fears over drug pricing have weighed on the company but PBMs have not been in the cross-hairs like the drug makers. The company’s PBM-retail integration gives it supply chain and pricing stability and should help it to capture a growing market of healthcare needs. Shares trade for just 13.6 times trailing against a five-year average of 20 times earnings.
Honeywell International (NYSE: HON) shares underperformed for much of last year on fears that the change in leadership would change the company’s strategy and best of breed status. CEO Darius Adamczyk has since reaffirmed the company’s focus on automation and software, maintaining its leadership in industrial manufacturing.
Honeywell has already invested the capital to upgrade its factories with state-of-the art automation and its proprietary internal efficiency system, HOS Gold, should help the company maintain industry-leading margins. The company is integrating its recent acquisition of Intelligrated for its entry into faster-growth warehouse automation to support revenue growth. Shares trade for 19.3 times trailing earnings, below the 19.7 times average over the last five years and against expectations for 4.8% earnings growth in the next four quarters.
Risks To Consider: While dividends could continue to rise for these best-of-breed names, stock prices may still come under pressure during a market selloff.
Action To Take: Protect your dividend portfolio — these are the three best long-term dividend stocks to buy now.
— Joseph Hogue
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Source: Street Authority