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 two companies that satisfy this criterion:
CVR Partners, LP
CVR Partners, LP (UAN) is a Delaware limited partnership formed by CVR Energy Inc. It engages in the manufacture of nitrogen fertilizers. It operates manufacturing facilities in Coffeyville, Kansas which produce ammonia and urea ammonium nitrate (UAN) fertilizers. Its nitrogen fertilizer manufacturing facility is the only one in North America to use a petroleum coke gasification process to produce hydrogen, and it generates about 5% of total UAN sales in the United States.
This stock’s current dividend yield sits atop the Value Line Survey at nearly 10%. And, although third-quarter results came up a bit short of expectations, and suggest that a plant turnaround effort will continue to stifle efficiency throughout the remainder of the year, analyst Mario Ferro believes that the plant expansion will help boost production by 50% in 2013. Ferro thinks that depleted corn inventories will need to be replenished, thereby driving demand for fertilizer higher. Longer-term, he sees improving standards of living in emerging markets as a catalyst to support strong cash flow and continued dividend increases.
That said, this issue does have its flaws. Ferro warns that limited partnerships carry unique, and often complex, tax reporting requirements that may scare off those not wanting to invest the time and effort. Also, management has noted that it continues to scan the acquisition market for viable candidates. Any purchases could potentially limit the cash reserves and future dividend hikes, especially if another difficult planting season emerges or the aforementioned plant expansion does not go according to plan. Investor interest is likely to pick up along with demand trends, making dividend increases vital in order for UAN to maintain a top notch yield.
Lockheed Martin (LMT) provides a broad range of products and services to the world’s governments and commercial customers. The company’s areas of concentration include space and missile systems, electronics, aeronautics, and information systems. Its program base includes F-16, F-22, F-35 aircraft, ballistic and other missile systems, C-130 military transport, and Titan launch vehicles. In 2011, 82% of sales were derived from the United States Government.
The company, as has been the case with most defense-equipment makers, is facing a stiff headwind. The possibility of military spending cuts continue to loom large, threatening to further thwart sales beyond the 2% top-line slip reported in the third quarter. Although cost controls helped Lockheed weather the storm and post double-digit earnings growth in the most recent period, Senior Analyst Ian Gendler envisions a far tougher earnings environment going forward. He calls for a 12% share-net decline in the fourth quarter and a 4% dip in 2013.
Even still, Gendler believes that Lockheed is far better positioned than most in this space, noting its vast portfolio of products and its involvement with the F-35 program. He believes that the fifth-generation fighter may well be a staple in the U.S. Air Force’s arsenal for years to come. Indeed, the Pentagon’s plan on procuring 2,400 of these planes plus interest from several partner nations ought to keep the program up and running for the foreseeable future. As a result, cash flow generation is expected to remain bountiful in the years ahead.
Management is likely to keep investors in mind. Annual dividend increases have been a staple in years past as have share repurchases. We see nothing suggesting a departure from this strategy, and believe that this issue will continue to deliver a superior dividend yield out to 2015-2017. The company receives good ratings for Financial Strength and Safety, further supporting our assessment.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.