Rising dividends lend appeal to stocks

John Dorfman
| Tuesday, Oct. 9, 2012, 12:01 a.m.

With banks paying less than 1 percent interest on savings, stocks that pay good dividends have been popular the past two years.

At some point the tide will turn, and investors will get hungry again for capital appreciation. Regardless of investors' fashions, my work during the past 14 years suggests that stocks with rising dividends and an above-average dividend yield are generally good bets.

Since October 1998, I have written 12 columns recommending stocks with “dividend appeal,” defined as an above-average dividend yield combined with dividend growth. On average during the 12 months after publication, my selections in this series have returned 19.2 percent. The Standard & Poor's 500 Index during the same 12 periods has returned an average of 7.4 percent.

My Dividend Appeal recommendations have been profitable 11 times out of 12 and beaten the S&P 500 10 times out of 12. Last year's selections, published in October 2011, just edged out the S&P, rising 25.6 percent while the index returned 24.9 percent.

Bear in mind that past performance doesn't guarantee future results. The performance of my column recommendations is theoretical and doesn't take into account trading costs or taxes. Results of my column recommendations should never be confused with those for real-money portfolios that I manage.

Why do stocks with dividend appeal do well? For two reasons. First, over the long term, about 40 percent of stocks' total return has come from dividends and the reinvestment of dividends. Second, the payment of a dividend — or especially, its increase — is a concrete sign that management believes that earnings prospects are solid.

There are more than 3,000 stocks with a market value of $250 million or more. About half of them pay a dividend. To be considered for this column, a stock had to provide a dividend yield of 4 percent or more. (The yield is simply the dividend as a percentage of the stock price.) About 18 percent of stocks offer a yield in that range.

In addition, a stock had to show a history of growth in the dividend to be considered. The dividend had to increase by an average of 10 percent a year during the past five years. Only about 1 percent of all stocks met both of the criteria.

Probably the cheapest stock in the bunch is Cliffs Natural Resources Inc. (CLF) of Cleveland, an iron ore producer. You can buy Cliffs shares for less than book value and for only 5 times earnings. It yields more than 6 percent in dividends.

Why so cheap? Well, China has been a major importer of iron ore, needing it to make steel for a huge and powerful construction boom. But China's growth is slowing, and some people fear that the country is headed for recession. That could force iron prices down.

I'm cautiously optimistic about China, and it's worth noting that Cliffs gets about 80 percent of its revenue from North America.

One of the strongest balance sheets in the group belongs to Terra Nitrogen Co. L.P. (TNH). Based in Deerfield, Ill., Terra makes fertilizer. It has been profitable eight years in a row and posted record earnings last fiscal year. The company is debt-free, and the stock yields more than 7 percent in dividends.

Another high-yielding stock is Diamond Offshore Drilling Inc. (DO) of Houston. On the minus side, analysts don't expect earnings this year or in the next two years to approach the record levels of 2008-2009. On the plus side, day rates for renting an offshore oil rig have been moving up steadily the past couple of months. Diamond offers a 5 percent dividend yield and has been profitable for seven consecutive years.

Molex Inc. (MOLXA) of Lisle, Ill., makes electric and electronic parts such as connectors, cable assemblies, switches and antennas. It's an unglamorous company, and the stock is about where it was 14 years ago. However, it has shown earnings progress of late and offers a 4 percent dividend yield.

For my final recommendation, I highlight Meredith Corp. (MDP), a media company from Des Moines, Iowa. Meredith publishes 19 magazines, including Parents, American Baby, and Better Homes & Gardens. It also owns 12 television stations, including CBS affiliates in Atlanta and Phoenix, and Fox stations in Portland and Las Vegas. It has turned a profit in nine of the past 10 years, the exception being the recession year of fiscal 2009. It yields 4 percent.

John Dorfman is chairman of Thunderstorm Capital LLC in Boston. He can be reached at jdorfman@thunderstormcapital.com or 617-542-8888.

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