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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. Here we take a look at two stocks from the list, Seadrill (SDRL) and Agrium, Inc. (AGU).

Seadrill

Seadrill is a leading offshore drilling contractor providing worldwide offshore drilling services to the oil and gas industry in over 11 countries, including the United States, Angola, Malaysia, Thailand, Brazil, and the United Kingdom. The company owns and operates a fleet of 22 jack-up rigs (as of year-end 2013), 3 tender rigs, 19 semi-submersible rigs, and 15 drillships through various global subsidiaries.

Seadrill reported mixed results in the March period of 2014, despite a solid overall operating environment. Revenues of 1.22 million were slightly below the year-earlier figure, however, earnings rose sharply to $1.58 a share (excluding non-recurring gains or losses). That said, despite higher offshore exploration and drilling activity in the Gulf of Mexico and Africa, day rates for the company’s high-end assets have come under pressure due to an industrywide slowdown in capital spending by most oil companies. Too, higher rig capacity in recent years has led to excess market capacity, which could have an impact on earnings going forward. That said, long-term drivers remain, including contract extensions for Brazilian clients. The company will also tap the term loan market in order to improve the amortization profile of its long-term debt, creating a stronger cash balance to cope with any headwinds that may arise.

Seadrill maintains a very favorable payout policy where most of its earnings are paid out to investors. The dividend is projected to increase over the next few years, which we believe is a sustainable outlook considering the company’s strong earnings power. The 3- to 5-year projected yield of 7.9% (as of May 9, 2014) remains well above the Value Line median. Too, strong scores for Price Growth Persistence (85) and Earnings Predictability (80) make this equity worthy of consideration.

Agrium

Agrium Inc. is a leading producer and marketer of nitrogen fertilizer and potash. It supplies agricultural products and services in North and South America, as well as Australia. The company is headquartered in Calgary, Canada and has three primary operating segments including Retail, Wholesale, and Advanced Technologies. Nitrogen-based fertilizers account for 37% of wholesale sales (as of 2013). Agrium operates about 1,250 retail agricultural centers in the U.S., Canada, South America, and Australia. Its main competitors include CF Industries (CF) and Potash Corporation (POT).

Agrium had a slightly disappointing March quarter. Share net fell well below the previous year figure and our estimate, to $0.08 a share, likely driven by poor revenue growth, specifically in the company’s Wholesale business. Poor demand for fertilizer products was the catalyst for the decline. In addition, reduced rail availability, and a lag in nutrient prices contributed to the weak performance, as well. That said, results are seasonally better in the June interim considering that the spring application season is in full effect. Too, phosphate markets should improve with robust demand from the American segments. Stability in the global potash markets should be more of a long-term driver, thanks to supply agreements reached with China and major suppliers, as well as greater demand from other regions.

Income-seeking investors with a degree of patience can find some long-term value here. Potash suppliers could see demand spike in the market over the long haul, which augurs well for the company’s long-term earnings growth potential. Too, the yield currently sits around 3.3%, with a projected 3.4% in the 3- to 5-year haul, which is above the Value Line median. In addition, management has been aggressively buying back shares and paying off debt which should help maintain a healthy yield in the long run. We expect yearly payout to reach $4.00 a share by 2015, and $5.50 a share by 2018. Investors will also be pleased with the strong grade for Financial Strength (A).

At the time of this article’s writing, the author did not hold positions in any of the companies mentioned