This week we feature Tim Plaehn, dividend and income investing expert and editor of The Dividend Hunter, a new income service for investors looking to capture yield and gains from the hottest dividend stocks. Prior to joining Investors Alley Tim was an F-16 pilot, stock broker, certified financial planner, and contributor to USA Today, The Houston Chronicle, Seeking Alpha, and many others.
If you only focus on yield when picking dividend stocks, you are likely missing out on a great opportunity to grow the capital value in your account while at the same time earning an attractive dividend yield. Picking income stocks that will grow the dividends provides two big benefits to your portfolio. One, a rising dividend will force the market to increase the share price at a comparable rate. Second, a company that has consistently increased dividends is not about to announce a dividend cuts. All dividend reductions come from stocks that have been paying a level, high yield and then shock investors with a reduction.
Consider a stock with a current 4% yield that is able to increase the distribution rate by 20% per year. For the yield to stay at 4%, the share price must grow by 20% over the year to match the rate of dividend growth. As a result, an investor would generate a 24% or so total return. If the company can maintain the dividend growth pace for 3 to 4 years, the investment value and yield on original investment value will double over that time period.
The capital gains through dividend growth approach leads to stocks that are pass-through entities. The most common types are Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs), which are required to pay most of the profits out to investors as cash distributions. As a result, finding a fast growing REIT or MLP will generate a fast growing dividend that pulls up the share price as the distribution rate increases. With the current growth in the U.S. oil and gas sector, we currently find stocks meeting our distribution growth criteria among the energy midstream companies providing energy transport, storage and processing services from the well head to the gas pump. However, a few real estate companies also fit the dividend profile we are searching for.
Here is a list of 7 companies that should ratchet up their dividend rates over the next several years, providing near-automatic share price gains and 20% or better annual gains plus dividends total returns.
- Williams Companies (WMB) – In the energy sector, MLPs provide attractive yields with many of the midstream companies growing distributions by 8% to 12% per year. Under the typical partnership agreement, the company holding the general partner (GP) share of the business receives extra payments, called incentive distribution rights. These grow even faster as the dividends paid to limited partners are increased. As a result, a publicly traded GP company can grow its dividends at a multiple of the growth rate from the MLP company. WMB is the general partner and owns 70% of the LP units of Williams Partners LP (WPZ) and 50% of the GP interest and 23% of the LP units of Access Midstream Partners, LP (ACMP). For 2014, WMB has forecast dividend growth of 22% and close to 20% in 2015. WMB currently yields 3.9%.
- Targa Resources Corp. (TRGP) operates solely as the general partner of Targa Resources Partners, LP (NGLS). In 2013, the NGLS distribution rate was increased by 10% and the TRGP dividend grew by 32%. For 2014, the company provided dividend growth guidance of 25% plus. TRGP currently yields 2.5%.
- At the start of 2013, ONEOK, Inc. (OKE) was an energy conglomerate, owning a public gas utility company, providing natural gas energy services including transportation and storage, and functioning as the general partner of ONEOK Partners, LP (OKS). The OKS limited partnership is one of the largest natural gas gathering processing and pipeline companies in the U.S. Over the last 12 months, OKE shut down the money losing energy services business and spun-off the gas utility, leaving it as a pure play GP. With its year-end earnings report, OKS forecast dividend growth of 25% per year from 2014 through at least 2016. The current yield is 2.7%.
- Working in the opposite LP to GP direction, Valero Energy Partners, LP (VLP) was spun-off in December by Valero Energy Corp. (VLO). With this type of newly formed MLP, Valero Energy will sell – drop down in MLP jargon – VLO’s midstream assets to VLP as a way to monetize assets that are not core to VLO’s main refining business. As a result, VLP is almost guaranteed to be receiving drop downs several times a year priced so that the VLP dividend can be increased every quarter. The VLP distribution rate is forecast to grow by at least 20% per year through 2017. VLP currently yields 2.15%. As of March 2014, VLP has not yet received a drop down, so there is a good probability of a very large dividend increase before the end of this year.
- The Geo Group (GEO) is a global provider of privately owned and managed correctional and detention facilities for all levels of government. In 2012, the company restructured and began operating as a REIT on January 1, 2013. Over the first four quarters as a REIT, the dividend has been increased by 14%. Growth opportunities exist on numerous fronts in the GEO niche of commercial real estate. GEO currently yields 7.2% and dividend growth of 10% to 15% per year should be well within the company’s grasp.
- Simon Property Group Inc (SPG) stands by itself among shopping center REITs. With a $50 billion market cap, you would think a company this large could not continue to grow at the rate it has, but year after year SPG continues to rack up industry leading growth numbers. I once heard a top manager state on an earnings conference call that taxable income was growing so fast the company was having trouble deciding how much to increase the dividend to stay in line with the REIT rules. SPG yields 3.1% and has been growing the dividend at 10% to 15% per year.
- Aircastle Ltd. (AYR) is neither an MLP or REIT. Which means the company is not required to pay a high dividend. AYR is a commercial aircraft leasing company, buying jet airliners and leasing them out to airlines around the world. The company’s business has always been steady and free cash flow heavy. However, during the financial crisis the dividend was reduced to $0.40 per year from the previous $1.00. Over the last three years the company has again started a policy of regular dividend increases. The current $0.20 per quarter, $0.80 per year, is 17% higher than a year ago and AYR yields 4.2%. The nice part of Aircastle’s business is that the company throws off a steady $4.00 per year in free cash flow, so there is plenty of room for the dividend to grow.
The dividend growth strategy may be a different approach if you have focused more on the yield of your dividend stocks. Are you holding any of these investments? What’s been your experience with a dividend growth strategy? Are you interested in hearing more from me about this? Feel free to drop me a line at [email protected].