Dividend Growth Points the Way to Prosperity

Dividend Growth Points the Way to Prosperity
Monday July 28, 12:00 pm ET
ByJonathan Heller,

In the midst of another earnings season, we are yet again reminded of the many ways to measure a company's recent success (or lack thereof). It's all about earnings, at least that's what's typically reported first.

I'm not trying to denigrate earnings as a metric, but the variety of methods used (basic EPS, diluted EPS, EPS from continuing operations, the list goes on), can be confusing to investors. Even the analysts don't always agree what the most appropriate measure is.

Beyond that, it is clear that earnings can lie -- and I'm not even referring to fraud, but rather legal methods company's can use to make the results look better, at least in the short term.

Dividends, however, don't lie. I do acknowledge however, that David Einhorn has made a compelling case that this may not be true in the case of Allied Capital , but that's another story.

Dividends must be paid in cash, and cannot be manipulated the way earnings can. What you see is what you get. A company cannot declare a $.25 dividend and pay out $.15, nor can it decide to pay it out in the form of excess inventory instead of cash.

The downside, however, is that companies that run into performance trouble can cut their dividend, or eliminate it altogether. In some of these cases, the punishment (i.e. a declining stock price) is severe, and it might have been better had the company never committed to a dividend policy in the first place.

With that as a backdrop, I am a big believer that dividend growth can be an excellent indicator of true company health, performance and a confident management team. This is not about yield, but rather rapid and perennial growth in what a company is willing to return to its shareholders.

In a way, this is self-policing as companies must keep their payout ratios low enough to allow for reinvested capital, and room for further growth.
The intent here is not to suggest this is the only way to truly measure company health or growth, but rather one method that can be applied to dividend-paying companies. We recently screened for dividend growers meeting the following criteria.

(As always, with any stock screen, further research on each individual company is paramount):

• Market cap between $500 million and $10 billion. (This is intended to identify smaller companies which might have room for further growth.)
• A payout ratio less than 30%. (Payout ratios that are too high are not sustainable, and may lead to dividend cuts or eliminations.)
• Total debt-to-equity less than 30%. (Too much debt can constrain a company's ability to pay dividends.)
• Consecutive increases in dividends for at least seven years. (This demonstrates both a strong track record, and management's intent.)
• Five-year dividend growth rate at least 10%. (This indicates rapid increases in dividends paid.)
• All industries except financials. (I am skittish on financials at this point.)