We cover a lot of different topics in my premium income newsletter, High-Yield Investing. One thing I make a point to feature in each issue is a detailed screen of some sort for interesting income opportunities.
Sometimes I run straightforward, simple screens, like last month’s search for low-cost, high-yield equity income funds.[ad#Google Adsense 336×280-IA]Other months we might track down potential short squeeze candidates, talk about ways to combat inflation or hunt for highly efficient businesses that generate the most revenue per employee.
This month, I wanted to get back to basics and pinpoint a few stocks that are poised for meaningful dividend hikes in the near future.
According to FactSet Research, dividend distributions among S&P 500 companies have increased for 11 straight quarters. Over the past year, aggregate payments are up 4.8% to $431 billion. That’s the good news.
The bad news is that many companies have reached the upper limits of what they can afford to distribute relative to current profits.
In fact, 44 members of the S&P (almost 10%) have unsustainable payout ratios above 100%, meaning they aren’t earning enough to cover their dividend payments. Many of these companies may have trouble maintaining their current payout — let alone increasing it.
Still, after a mild “earnings recession” in which corporate profits slumped for a few quarters, bottom lines are starting to strengthen again. More than three-fourths (76%) of S&P companies to report first-quarter earnings through April 20 have managed to beat estimates. And the average growth rate of 9.2% is tracking to be the highest since 2011.
That has helped fuel a number of recent dividend hikes, some of which have directly benefitted the portfolio holdings in my newsletter.
What companies might be next? Well, to answer that question I screened for companies with a strong dividend track record (rising payments for at least the past three consecutive years), a positive 2017 earnings outlook, and ample room for further increases (modest payout ratios below 60%).
This test proved tougher than expected. Most companies prefer to make their annual increase in the first quarter and won’t have another raise until next year. The intent here is to pinpoint potential dividend hikes over the next few months — so that eliminates many contenders.
The biggest hurdle that tripped up the remaining candidates was an excessive payout ratio. I can’t count the number of quality companies that met all other requirements, only to be eliminated once I found out they were paying out more than 90% of their profits — or 100% in the case of pharma giant Merck (NYSE: MRK) and a few dozen others.
Here are some of the more notable survivors.
These are all good potential candidates you might want to consider. But keep in mind, this is just a screen. You should evaluate them in more detail on your own and simply consider this a starting point for further research to see if they might be a good fit.
That being said, I like LyondellBasell (NYSE: LYB), a well-positioned petrochemical maker benefiting from low-cost, homegrown feedstocks.
Ameriprise (NYSE: AMP) is one of my former recommendations. The brokerage firm offers a generous total yield (dividends plus stock buybacks) and has already advanced from $82 in mid-February to $128 today. But the yield is shy of my 4% minimum threshold for inclusion in High-Yield Investing.
The most intriguing on this list is Qualcomm (Nasdaq: QCOM), a former growth darling that is evolving into a mature dividend payer. The stock has historically offered a decent 2.5% yield on average over the past five years. But today, you can lock in a payout above 4% — the result of a steep pullback in the shares toward a 52-week low of $50.
Virtually every 3G network on the planet and most 4G networks are governed by Qualcomm’s technology. So every time a cell phone is sold and connected, the company is entitled to a small licensing royalty. Multiply that by the 250+ million cell phones that are sold each quarter, and you can see why the company is swimming in cash.
Keep in mind, this royalty income is almost pure profit, with margins close to 100%.
But the company isn’t just living off yesterday’s patents. It’s also one of the top suppliers of cellular baseband chips (it controls a dominant 66% share of the market) and other critical components found in popular Android-based models made by Samsung and others.
So whenever a smartphone is sold, Qualcomm is paid twice: a passive royalty fee for utilizing its technology, as well for whatever parts were installed in the device to make it work. It’s a wonderful, cash-generating business. A little too wonderful, in fact — since it has attracted the attention of antitrust regulators in Taiwan and South Korea. Not to mention a legal dispute with Apple (Nasdaq: AAPL) (which at the very least diminishes the chance of installing more parts in future iPhones). These legal battles could drag on and have an uncertain outcome.
That explains the selloff in QCOM. I think the company will ultimately prevail with its economic moat intact, although it’s probably facing some fines and a possible reworking of the calculations used to determine royalty payments (this already happened in China). It might be prudent to see how things shake out before investing, but this is a stock worth watching.
— Nathan Slaughter
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Source: Street Authority