When the economic climate gets rough, many companies are forced
to reduce or even outright eliminate their dividends. They have no
choice:Cash flow falls, and any efforts to sustain adividend at
current levels bleedscash from thebalance sheet .
But there's a straightforward way to assess not just the safety
of a dividend, but its growth prospects as well. [In fact, this is
a key part of what wecall thenet profit growth. Indeed, across the
S&P 500, S&P 600 (a small-capindex ) and S&P 400 (a
mid-cap index), it's possible to find dozens of companies that have
been able to generate double-digit average annual gains in those
metrics during the past five years.
Yet among these steady growers, it's also possible to find a
more limited group that also pays a dividend. Once you're focused
on this group, there's a simple way to calculate how much a
dividend might grow. In a nutshell, the lower thepayout ratio (the
amount offunds spent on dividends, divided bynet income ), the
higher the potential dividend growth rate.
as an example. Coca-Cola has boosted sales, cash flow and net
profits at a roughly 12% annual pace during the past five years.
Yet Coca-Cola's dividend has risen at a more tepid 8% pace in that
time. That's because Coca-Cola already pays out so much of its
income into dividends -- 51% in the past 12 months -- that it's
hard-pressed to do much more for the dividend without creating an
uncomfortably high payout ratio. Coca-Cola's per-shareearnings will
likely rise just 4% in 2012 to $2, according to analysts. And
they're likely to grow less than 10% in 2013 as well, meaning
future dividend growth will likely be quite muted.
For a number of other companies, near-termprofit growth may also
slow if we're faced with a weakeconomy in 2013. But they can still
hike their dividends at a vigorous pace -- if their current payout
ratio is quite low.
Apple (Nasdaq: AAPL)
as an example. The consumer electronics giant offers a
so-sodividend yield of 2%. But it can do so much better in the
future simply because its currentdividend payout ratio is a quite
reasonable 24%. If Apple took that payout ratio to 50%, then the
dividend yield would rise to 4%. Frankly, with more than $100
billion in net cash parked on its books, Apple could easily afford
to return all of its net income to shareholders in the form of a
dividend. That would work out to be a 9% dividend yield.
Solid Growth and Reasonable Payout Ratios
Every company on this table is well positioned to deliver steady
and robust dividend gains. Not only have they proven their ability
to steadily boost sales and profits in recent years, but analysts
predict that each of these companies will boost sales and profits
in the next two years as well.
Glancing at the table above, the dividend yields may seem a bit
subpar. But it's crucial to remember the power ofcompounding . If
you buy these stocks and hold them for a considerable period of
time, then dividend yields down the road (on your originalcost
basis ) are likely to become much more robust. The fact that they
have low payout ratios means they can afford to keep pushing the
dividend higher, even in years when sales and profit growth fail to
materialize. Said another way, these companies are quite unlikely
to be forced to cut their dividends in tough times, thanks to those
already-low payout ratios.
Risks to Consider:
Tax rates on dividends may steadily rise in coming years as
Washington seeks new ways to raiserevenue . That's why
dividend-paying stocks are often best owned in tax-shielded
Action to Take -->
Capturing rising dividend streams can be a safe approach in
uncertain markets. It's hard to know what to expect from themarket
in any given year (indeed the S&P 500 is below where it stood
in 2000). But solid and rising payouts can ensure you'll still reap
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