How to Invest in Dividend Stocks - Investment Ideas

With short-term interest rates near zero for the foreseeable future and rumors of the 30-year bond rally coming to an end, many yield-hungry investors are turning once again to dividend stocks.

But beware the siren call of high-yielding stocks.

A high single-digit or low double-digit yield may look attractive at first glance, but yields that fat are rarely sustainable. Consider what a dividend yield is - the current annual dividend divided by the current stock price. A quarterly dividend check will provide little comfort if you invest in a stock that ends up plummeting.

Moreover, that dividend check is no guarantee. Companies are not required to make dividend payments like they are debt payments. If times get tough and money gets tight, checks to the bank and to bondholders will get sent out before your dividend check.

It's not uncommon for high-yielding stocks to slash or suspend dividends indefinitely. One only needs to look at investors who picked up shares of General Motors or any of the "stable" bank stocks in 2008 because of their alluring yields to realize that juicy dividends often don't last.

Think Long-Term

For yield-conscious investors looking to hold a stock for the long haul, there are a number of metrics to look at besides the current dividend yield.

One such metric is the company's payout ratio. The payout ratio is simply the percentage of net income a company pays out to shareholders in dividends. Typically the higher the payout ratio the less room a company has to raise its dividend. If the company becomes distressed, a high payout ratio can signal a significant cut is on the way.

Another lesser-known item to consider, particularly for long-term investors, is yield on cost. Yield on cost is the current annual dividend divided by your original cost per share. For investors holding for several years or even decades, this can be dramatic.

Consider the world's most successful investor - Warren Buffett. The Oracle of Omaha picked up shares of Coca Cola (KO) in the late 1980s through his company Berkshire Hathaway for an average cost of $6.49 per share. While the share price has soared, Berkshire also receives an annual dividend of $1.76 per share. That means its yield on cost is an incredible 27.1%! Not too shabby.

It's not uncommon for solid businesses to distribute more and more of their earnings to shareholders through higher dividends as they mature. Bigger companies have less growth opportunities and compete in crowded markets, so they plow back less of their earnings into the company and more into your wallet. This could mean a decent dividend yield today becomes a huge yield in the future. For instance, a company that raises its dividend at an average of 19% per year will essentially double it every 4 years. That means your yield on cost will double too.

Below is a list of 6 companies currently yielding more than 1.5% who have a history of raising their dividends but still have relatively low payout ratios. They also have total debt less than 50% of total capital and are trading with a PEG ratio of less than 1.5. The stock must also be either a Zacks #1 (Strong Buy) or #2 (Buy) Rank.

Here's the list:

1. Guess Inc. (GES)

Current Dividend Yield: 1.9%
5-yr Dividend Growth Rate: 33%
Payout Ratio: 22%
Debt to Total Capital: 2%
PEG ratio: 0.9
Zacks Rank: 1 (Strong Buy)

2. Buckle Inc. (BKE)

Current Dividend Yield: 2.2%
5-yr Dividend Growth Rate: 26%
Payout Ratio: 30%
Debt to Total Capital: 0%
PEG ratio: 1.4
Zacks Rank: 1 (Strong Buy)

3. International Business Machines (IBM)

Current Dividend Yield: 1.8%
5-yr Dividend Growth Rate: 23%
Payout Ratio: 24%
Debt to Total Capital: 49%
PEG ratio: 1.3
Zacks Rank: 2 (Buy)

4. CSX Corp (CSX)

Current Dividend Yield: 1.5%
5-yr Dividend Growth Rate: 32%
Payout Ratio: 26%
Debt to Total Capital: 46%
PEG ratio: 1.3
Zacks Rank: 2 (Buy)

5. Molson Coors Brewing Co (TAP)

Current Dividend Yield: 2.4%
5-yr Dividend Growth Rate: 15%
Payout Ratio: 29%
Debt to Total Capital: 16%
PEG ratio: 1.1
Zacks Rank: 2 (Buy)

6. Accenture plc (ACN)

Current Dividend Yield: 1.9%
5-yr Dividend Growth Rate: 17%
Payout Ratio: 32%
Debt to Total Capital: 0%
PEG ratio: 1.3
Zacks Rank: 2 (Buy)

Conclusion

In this era of ultra-low interest rates, it's understandable that dividends are finally making a comeback. Just remember to be leery of those tantalizing yields. If you have a long time horizon and plan to hold for years or even decades, look beyond the current dividend yield and consider yield on cost.

Todd Bunton is the Growth & Income Stock Strategist for Zacks.com

 
ACCENTURE PLC (ACN): Free Stock Analysis Report
 
BUCKLE INC (BKE): Free Stock Analysis Report
 
CSX CORP (CSX): Free Stock Analysis Report
 
GUESS INC (GES): Free Stock Analysis Report
 
INTL BUS MACH (IBM): Free Stock Analysis Report
 
MOLSON COORS-B (TAP): Free Stock Analysis Report
 
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