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10 Stocks With A Sustainable Dividend Growth Rate

 August 11, 2010 09:30 AM
 


In the past we have looked at the importance of a company's ability to sustain its dividend. However, as an investor in dividend growth stocks, it is not enough to simply sustain the dividend – I want to own companies that are capable of sustained dividend growth. Needless to say, this is a little more difficult to evaluate, but here are few important things to consider…

Revenue Growth

The top line drives the bottom line. You can only cut costs so far, for a business to grow and thrive it must find ways to grow sales. This can be done through acquisitions, expanding markets, developing new production or entering a new line of business. For a company to sustain a growing dividend over the long-term, it must find ways to continuously grow its business. For some companies it easier and less risky to cut costs and many will stop there.

Earnings Growth

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Many companies have learned the hard way that growth for the sake of growth is not always a good thing. If growth is not managed effectively and efficiently, it will be detrimental to long-term viability of the business. Management must ensure growth projects are monitored, controlled and well-run to ensure a profit is generated. Many great ideas have failed as a result of poor execution. Sometimes competitors will watch and correct the execution problems and turn your failed growth idea into their success.

Cash Flow Growth

Revenue and earnings growth are good, but ultimately they must convert to increased cash flow to provide the means for sustained dividend growth. Having the cash on hand is not enough. There must be a commitment on management's part to grow the dividend. Ideally, this commitment will eventually grow into a culture of dividend growth that the company takes great pride in.

Business Outlook

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One of the most difficult things to judge are the future prospects of a company. Certain questions have to be answered. Is the company in a declining industry? Will it be able to reinvent itself in a way that will allow it to sustain growth? What external force could radically change the prospects of the company? These same questions are being asked by the company's board, and they are equally hard for management to answer even with full access to insider information.

Below are ten companies with an average 10-year free cash flow growth rate exceeding their average 10-year dividend growth rate:

CurrentAverage 10-yr Growth Rates
CompanyAnalysisYieldDividendRevenueFCF
Abbott Labs (NYSE: ABT)Link3.40%9.01%9.02%14.38%
Becton, Dickinson (NYSE: BDX)Link2.06%15.22%7.74%31.25%
Cardinal Health (NYSE: CAH)Link2.18%25.90%15.96%138.39%
Colgate (NYSE: CL)Link2.65%11.42%5.43%15.42%
CenturyLink, Inc. (NYSE: CTL)-7.97%61.07%13.92%73.94%
J&J (NYSE: JNJ)Link3.52%13.52%9.51%14.99%
Procter & Gamble (NYSE: PG)Link3.00%11.16%7.84%20.92%
RPM International (NYSE: RPM)Link4.40%5.45%7.25%58.62%
AT&T, Inc. (NYSE: T)Link6.33%5.47%12.51%29.50%
Wal-Mart Stores (NYSE: WMT)Link2.34%18.93%9.57%33.71%

It is important to note that only three of the above stocks (ABT, RPM and T) have revenue growth in excess of dividend growth. Needless, to say before buying you must consider the future prospects for each company and determine if the growth rates are sustainable in the future. As with yield, dividend growth carries its own risk. If the rate is too high, the company will have a hard time maintaining it going forward. If the rate is too low, it will not keep up with inflation and the shareholder will lose purchasing power.

Full Disclosure: Long ABT, CL, CTL, JNJ, PG, T, WMT. See a list of all my income holdings here.

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