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, Southern Copper (SCCO), Copano Energy (CPNO), and Bank of Montreal (BMO) 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 Garmin LTD (GRMN), which ranked higher for current yield than it did when using projected dividends.
Southern Copper is a leading integrated producer of copper, molybdenum, zinc, and silver, with mining, smelting, and refining facilities in Peru and Mexico. Principal operations involve mining, milling, and flotation of copper ore to produce copper concentrates; smelting of copper concentrates to produce blister copper; and refining of blister copper to produce copper cathodes.
Southern Copper appears headed for record earnings this year. Our view is based on increased metals prices as well as stepped-up output from the recently restarted Buenavista mine in Mexico following a three-week strike. More precisely, copper prices averaged $4.38 a pound in the first quarter of the year, up 34% from last year. Meantime, total copper mined increased 14%, to 124,200 tons, primarily reflecting 27,600 tons coming from Buenavista. Once it’s at full capacity, this site can produce 180,000 tons per year. After falling in May and June, copper prices have firmed in recent weeks. Combined with production increases, these prices should support a marked uptick in the bottom line this year.
Copano Energy gathers, treats, processes, markets, and transports natural gas in Texas, Oklahoma, the Rockies, and Louisiana. The company’s natural resource pipelines collect natural gas from wellheads or designated points near producing wells and deliver it to processing plants, third-party processing plants and pipelines, local distribution companies, and industrial consumers. The company owns approximately 6,700 miles of pipeline, 10 gas-processing plants, and one fractionating plant.
Copano Energy is an L.L.C. (limited liability corporation). Such concerns are normally income vehicles designed to pay cash distributions to their members, much like master limited partnerships. LLCs are “pass through” entities that pass through to their members all revenues, expenses, and income or loss. Distributable cash flow is more important for LLCs than GAAP earnings. Copano plans to pay out nearly all of its discretionary cash flow, which is, approximately, net income plus noncash expenses minus noncash revenues and maintenance capital outlays. Pipeline companies don’t need to reinvest much of their depreciation expense to maintain their assets, so most of that noncash cost is available for other uses, including cash distributions.
Copano has a solid position in the high-potential Eagle Ford Shale formation. As one of the earlier participants in this prolific lower Texas region, Copano has secured long-term gas supplies to process and transport and is expanding its activities by investing in both wholly owned assets and through joint ventures.
Bank of Montreal is the fourth-largest bank in Canada with 1,234 branches (2,076 ATMs). Also operates in the U.S. and 17 foreign countries. The company owns Harris Bankcorp (Chicago, IL), BMO Capital Markets— a full-service investment bank, and BMO Nesbitt Burns— the wealth management division. Acquired Mercantile Bancorp, Gerard Klauer Mattison, and CSFBdirect.
Bank of Montreal recently completed its acquisition of Wisconsin-based Marshall & Ilsley (M&I), a deal worth more than $4 billion. We believe that this was a good move for the Bank of Montreal. First, it more than doubled the number of Bank of Montreal branches in the United States, to about 700, while boosting assets 47% (to over $160 billion). The transaction also provides a good position in some lucrative Midwest markets, including Missouri, Kansas, and Minnesota. Although this deal won’t likely be accretive for a few years or so, it is expected to result in annual cost savings of approximately $250 million by the end of fiscal 2013. Given the current state of the U.S. banking sector, we wouldn’t be surprised to see more activity by Bank of Montreal going forward. That said, we look for the company’s earnings to moderate during the second half of this fiscal year (ends October 31st), on the heels of a relatively strong first half of 2011. This is largely due to integration expenses related to the recent acquisition.
At the time of this article's writing, the author did not hold positions in any of the companies mentioned.