Equity investors interested in income often start the selection process by looking at companies with large dividend yields. This is a logical place to begin, but can miss an important aspect of dividend investing—growth in distributions. A static dividend distribution will, over time, lose ground to inflation.
A good way to think about dividend growth for an investment already in a portfolio is “yield based on purchase price.” This divides the current dividend by the original purchase price. A growing dividend distribution will result in a yield based on purchase price that is above the yield when the investment was purchased. And, over time, a stock with a fast growing dividend distribution can often provide shareholders more income than would be attained by purchasing a stock that had a higher yield, but little or no distribution growth.
Although this reframing of dividends is helpful for investments that are already in a portfolio, it can also be used to differentiate between potential investment candidates. Each week in the Index section of The Value Line Investment Survey a screen of stocks with the highest projected 3- to 5-year dividend yields is run. Using this list as a starting point can be helpful, but comparing this list to a list that simply looks at the highest yielding equities can highlight interesting differences.
For example, comparing these two screens, American Electric Power Company (AEP), Cedar Fair, L.P. (FUN), and Reynolds American (RAI) all show up higher on the projected dividend yield list than they do on the current yield list—making them potentially more interesting to an investor than Potash Corporation (POT), which ranked higher for current dividend than it did when using projected dividends.
American Electric Power Company
American Electric Power distributes electric power to retail customers. The company has 10 operating utilities that service about 5.3 million customers in states that include Arkansas, Kentucky, Ohio, and Texas. It generates electricity through several channels including coal and lignite, natural gas, and hydroelectricity, among other sources. AEP also operates barging operations that transport coal and dry bulk commodities mainly on the Ohio, Illinois, and lower Mississippi rivers.
The near-term picture is a bit morose at the moment. This is because customer losses have hurt the bottom line, and are expected to continue to dilute earnings by about $0.07 a share this year. Meanwhile, the company has made regulatory filings in Ohio, and is also awaiting a rate settlement in Virginia, in an attempt to soften the blow of fewer clients. It also intends to expand its transmission business. Short-term challenges aside, AEP provides attractive prospects for income-oriented investors. The utility outfit has historically made dividend distributions well above The Value Line median. Moreover, the projected dividend payment for the 2014-2016 time frame makes the 3- to 5-year total return potential above average for a utility.
Cedar Fair, L.P.
Cedar Fair Fun owns and operates amusement and water parks in the United States and Canada. In total, the company operates 11 amusement parks, including Dorney Park and Wildwater Kingdom, both located in Pennsylvania and Knott’s Berry Farm, situated in California. In addition, the company owns five hotels.
Value Line analyst Alan House is cautiously optimistic about the theme-park operator’s near-term prospects. In times of economic weakness, individuals tend to visit these amusement parks instead of pricier vacation destinations. Earnings are estimated to grow more than three fold over the next two years because of the anticipated rebound in attendance. And management has been busy lowering its debt balance, and consequently, its interest expenses. The extra money is being put to good use through more aggressive marketing activities as well as new ride attractions. These efforts should do well in attracting more customers.
Income investors ought to be pleased by management’s decision to re-instate the quarterly dividend payment following a suspension that lasted for most of 2010. What is more, there was a 25% dividend increase made during the most recent quarter. Although the company’s dividend payments are significantly lower than historical periods, the projected $2.00 a share 2014-2016 distribution, makes these shares attractive for total return potential at the recent valuation.
Reynolds American is the second largest producer of cigarettes in the United States. The company’s major brands include Winston, Camel, Pall Mall, and Kool. Too, Reynolds manufactures smokeless tobacco options under the GRIZZLY and KODIAK labels. The company distributes its products through wholesale and retail channels, as well as directly to customers.
Demand for the tobacco manufacturer’s core brands should help the company deliver solid earnings this year. Although volume has been a bit weak, of late, it has offset this trend by price increases and a focus towards a leaner operating structure. Furthermore, the focus on marketing smokeless products should augment the company’s earnings potential. Smokeless tobacco products are appealing to some because they do not fall under strict smoking bans.
The equity has an attractive dividend yield, which is well above the Value Line median. What’s more, we expect the distributions to be increased over the 3- to 5-year period, making the stock an attractive selection for the long term.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.