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3 Absolute Must-Own Dividend Aristocrats

Tuesday, March 11, 2014 - 2:30pm

For investors that count on dividend payments to cover their living expenses, the prospect of a dividend cut can create real headaches. That's why some investors own only the income-producing stocks that have never cut their dividend.

It's easy to find such companies. Product planners at Standard & Poor's track a group of these steady Eddies in a category called Dividend Aristocrats. These are companies that have raised their dividend for at least 25 straight years. Right now, there are 55 companies that hold that distinction, as all of them managed to boost their payouts -- even during the economic meltdown of 2008 and 2009.

To be sure, some of these Aristocrats haven't showered a great deal of attention on their dividends in recent years. Take steelmaker Nucor (NYSE: NUE) as an example. Nucor's dividend stood at $1.44 in 2010 and has risen exactly one penny every year since. It's almost as if the dividend hikes are a mere token gesture as a way to maintain the Aristocrat status.

As we've noted here at StreetAuthority on a number of occasions in the past year, investors can no longer focus simply on a dividend yield but must instead focus on dividend growth. Companies that will boost their dividends at a decent annual clip will stay ahead of the curve as the Federal Reserve starts to allow interest rates to rise.

Most of the 55 Aristocrats seem to be boosting their dividends at a 5% to 6% clip these days (though can offer up enticing Total Yields through share buybacks and debt reductions). Only a handful of companies -- nine of them, to be exact -- can be considered to be great dividend growth stocks. All of them have boosted the payout by at least 10% in each of the past three years.

These companies have been sharply boosting dividends for a pair of reasons: Cash flow has been growing at a solid clip, and/or the payout ratios had been quite low but are beginning to rise.

Of course, if the payout ratios were so low that the dividend payments implied skimpy yields, then income-seekers aren't really interested. Here's a look at those nine companies in the context of their dividend yields.

To be sure, none of these stocks sport eye-popping yields. Target's (NYSE: TGT) recent cyber-security woes means you shouldn't expect much dividend growth in 2014.

But what about the rest of the pack? The ones that should hold the greatest appeal are the companies that still have payout ratios below 40%. That means that a modest rise in cash flow, coupled with a boost to the payout ratio, can translate into sustained strong dividend growth.

Notably, the Aristocrats with the highest current yields also have fairly high payout ratios, which means their dividends are only likely to grow in the future at a pace in line with cash flow growth.

Only W.W. Grainger (NYSE: GWW), Lowe's (NYSE: LOW) and Cintas (Nasdaq: CTAS) have room to boost their payout ratios. Intriguingly, all three companies are poised to benefit from an eventual upturn in construction spending in particular, or capital spending in general, as the economy strengthens.

The key takeaway: These firms boosted their payouts at a double-digit pace in each of the past three years and have a good shot at repeating that performance over the next three years as well.

Risks to Consider: A reasonably supportive economic backdrop has given these firms the confidence to boost their dividends at a solid pace, though it's too soon to know if the economy will continue to justify continuing confidence, as 2014 has gotten off to a slow start.

Action to Take --> The Dividend Aristocrat investment theme has resonated with investors, especially after certain companies proved their mettle during the financial crisis and ensuing economic doldrums. T

Though I've focused on companies in the group with the most robust dividend growth, investors can also focus on slower growers that have the best yields by investing in the SPDR S&P Dividend ETF (NYSE: SDY). Though the exchange-traded fund (ETF) has moved in lockstep with the S&P 500 throughout the market rebound, it is likely to hold up better in a market pullback, thanks to the defensive nature of high-yield stocks.

P.S. Do you know about the Total Yield investing strategy? We're so excited about this new method -- which has been proven to earn the highest returns with the least risk by focusing on companies that reward shareholders in three special ways -- that we've devoted an entire newsletter to it. Right now we're giving readers a glimpse of some of our top Total Yield stocks, including one that's gained an astonishing 247% over the past year. To get the name of this stock -- as well as 11 others that are currently posting "total yields" as high as 27.7% -- follow this link.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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