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Equity investors who are interested in income often start their selection process by examining companies with healthy dividend yields. This approach does make sense, but they can overlook a key aspect of dividend investing—growth in distributions. Indeed, an unchanging payout will eventually 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 figure is calculated by dividing 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.

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. Below are several companies that satisfy this criterion:

Manulife Financial Corp.

Manulife Financial Corp. (MFC) is the largest life insurance company in Canada. It is also a leading global provider of other financial products and services, which include pension products, annuities, and mutual funds to individual and group customers in Canada, the United States, and Asia. As of December 31, 2010, premium income accounted for the lion’s share of sales (49%), followed by investment income (25%), and income from other sources (26%).

Over the past year, management has been aggressively reducing the company’s equity market sensitivity via hedging initiatives. The goal is to bring down that statistic by 60% at the end of 2012 and 75% by the close of 2014. It should be mentioned, however, that hedging costs will probably weigh down earnings for a while. Despite that, Value Line analyst, Joel Schwed, contends that the benefits of reduced exposure and related volatility is ''definitely worthwhile’’.

Meanwhile, the company’s financial position remains solid. Indeed, the capital ratio is healthy, and the recent sale of the Life Retrocesion business ought to provide an additional boost to that figure. Importantly, Manulife’s capital position is in much better shape to withstand the potential impact of another sharp market downturn. This ought to help ensure that the dividend yield (currently at 4.4%) stays appreciable over the next three to five years. 

AEGON, N.V.

AEGON, N.V. (AEG) is one of the largest international diversified life insurance and financial services companies in the world. Major operations are in The Netherlands (where the headquarters are located), the United States, and the United Kingdom. At December 31, 2010, the life & protection unit accounted for 46% of profits, followed by the pension & retirement segment (43%), and other sources (11%).

The company’s earnings were under pressure in the third quarter, reflecting turbulent equity markets, a drop in interest rates, and a weakening U.S. dollar. Unfortunately, it seems that problems are persisting in the fourth quarter, which will probably result in lower share net for the full year. But on the positive side, deposits rose to a record level during the third period (driven by pensions and variable annuities in the United States), while AEGON’s capital position was healthy.

The stock has been trading at relatively low levels of late. We think that can be attributed, in part, to the company’s challenging near-term environment. The sovereign-debt crisis in Europe has only made matters worse. It should be mentioned, though, that AEGON has only about 3.5% of its assets in securities from the five weak European nations (i.e., Portugal, Ireland, Italy, Greece, and Spain). This leads us to believe the current dividend will be supported out to mid-decade. Moreover, we believe that these shares will recover nicely in time, supported by upbeat 2014-2016 prospects.

Transocean Ltd.

Transocean (RIG) is the world’s biggest offshore drilling contractor, operating in all the major offshore regions, including the Gulf of Mexico, the North Sea, and the Middle East. It specializes in technically demanding, deepwater/harsh environment drilling projects. The company’s fleet is currently comprised of 45 high-specification floating rigs, 26 midwater floaters, and 65 jackup rigs.

Business trends indicate that earnings will start to recover in 2012. Transocean is seeing greater interest across all rig categories, even the recently out-of-favor standard jackups. What’s more, stepped-up drilling in the U.S. Gulf of Mexico is a good possibility next year, since the industry will likely have complied with all the new regulations imposed after the Macondo well disaster in April, 2010.

We are upbeat about Transocean’s operating performance over the next three to five years as well. That’s partially because of rising demand for deepwater drilling. Most undeveloped oil is deep under water, and the company boasts the largest fleets of deep- and ultra deepwater equipment around. Also, the healthy balance sheet makes acquisitions possible. In fact, Aker Drilling of Norway was just purchased for $2.2 billion. That deal added two high-specification, harsh-environment drill ships on long-term contracts and two more now under construction, will be delivered in 2013. All told, the stock offers worthwhile, long-term capital appreciation potential and should be able to offer an attractive yield going forward.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.