Top 5 Dividend Stocks 2016

Many people invest in dividend-paying stocks to take advantage of the steady payments and the opportunity to reinvest the dividends to purchase additional shares of stock through dividend reinvestments that are offered through most major brokerages free of charge.  Below are a few tips for investing in dividend stocks we like to follow most of the time.

1.  Look for Businesses with Long Corporate Histories

“Time is the friend of the wonderful company, the enemy of the mediocre” — Warren Buffett

Buffett invests in businesses with long corporate histories. Wells Fargo, American Express, and Coca-Cola were all founded in the 1800s. IBM was founded in 1911. Wal-Mart was founded most recently out of Warren Buffett’s top five. The company is practically a start-up compared to Coca-Cola, Wells Fargo, and American Express — it’s been around since 1962.

Companies with long histories offer investors fewer surprises. These businesses know exactly what they do, and they do it well. Very few businesses continue to be successful for decades. As technology progresses, industries change. Consumer tastes change as well. For a business to thrive for such long periods of time it must either continuously reinvent itself, or exist in an industry that changes slowly.

2. Look for Businesses with Strong Competitive Advantages

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” — Warren Buffett

Buffett looks for businesses with strong, durable competitive advantages. To do well in stocks, you must think like a business owner. As a business owner, you would want your business to be able to beat the competition. More importantly, you’d want something that prevented the competition from ever being able to match you. That’s what a strong and durable competitive advantage offers.

3. Look for Undervalued Businesses

Buffett’s mentor was Benjamin Graham, the father of value investing. Graham pioneered investing in businesses trading below the value of their assets. His discipline in purchasing stocks he believed were trading at less than intrinsic value rubbed off on Buffett.

To find value in the stock market, one often has to look at the most “beat down” and “unloved” stocks. The most glamorous high-flying growth stocks are not where to look to find value. Value investors tend to be contrarians:

“Be fearful when others are greedy and greedy when others are fearful.” –Warren Buffett

Buffett is not a strict value investor; he also looks for high-quality businesses that are trading at or below fair value. Combining quality and value tends to produce superior long-term returns. Without quality, the value of a stock can quickly decline. Without a low price, a quality stock could take years of growth to catch up to its fair price.

4. Keep a Focused Portfolio

“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” –Warren Buffett

The higher your conviction in any one stock, the larger your portion of your portfolio you should allocate to this stock. If you are very confident that a stock is undervalued, the business has a strong competitive advantage, growth is likely to persist for the long run, and management is shareholder friendly, you should naturally invest more than you would in only a mediocre opportunity. If you look closely at Buffett’s portfolio, it is heavily concentrated — but he makes big investments only in extremely high quality businesses that have low business obsolescence risk.

5. Invest for the Long Run

“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” –Warren Buffett

Earlier in this article, the importance of investing in businesses with long histories was discussed. Dividend investors should look for longevity in the company’s in which they invest. Dividend investors should also look for investments they are willing to hold for years — or decades — at a time.

Buying and holding generates fantastic returns only when an investor holds shares of great companies that continuously compound shareholder wealth thanks to their strong competitive advantages. Investing for the long-run has another benefit: It is a tax-advantaged strategy. When an investor sells a stock (in a taxable account), they must pay capital-gains taxes. By not selling a stock, you are allowing the money you would have had to pay in capital gains taxes to continue compounding for you. This is one of the primary reasons behind Warren Buffett’s extremely long holding periods.

Holding stocks for long periods has a third advantage. Rarely buying and selling stocks greatly reduces portfolio turnover. Low portfolio turnover means lower frictional costs like brokerage transaction costs, slippage, etc. The lower you keep your investment related costs, the more money you have to actually invest. Holding for long periods of time allows your money to compound in your best ideas, is tax efficient, and reduces investment related costs; a win-win-win situation for individual investors.

6. Look for Shareholder Friendly Management

From the perspective of a shareholder, an excellent management team is one that creates real value for shareholders. The best managers will repurchase shares when stock prices fall and abstain when prices rise. If the business does not have great investment opportunities to reinvest corporate profits, the management will pay out excess cash flows as dividends to shareholders.

A truly high-quality management team will be well-versed in capital allocation. Corporations will issue debt at attractive prices and use the proceeds in intelligent ways.  Analyzing the moves a company’s managers make is a good way to understand their motivations. As a general rule, businesses with long dividend histories and share repurchases are shareholder friendly and make good investments. Finding the truly exceptional manager — like the next Buffett — is very difficult. But looking at the moves management has made is the first step.

7. Keep Thins Simple

“Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1.” — Warren Buffett

Investing can be extremely complex — if you want it to be. It can also be extremely simple, as the quote from Warren Buffett above exemplifies.  The first goal of investing should be to not lose money. With that taken care of, your only option is to make money. With safety as the first rule, investment methodology simplifies: Look for high quality businesses with long histories and shareholder friendly managements trading at fair or better prices; when you find them, buy and hold for the long-run.

Even though Buffett is an investing genius, he always looks for simplicity. When you think of complicated businesses and investment plans like Enron or Long Term Capital Management, the results can be devastating to your portfolio. It is far better to invest in easy-to-understand high-quality businesses within your “circle of competence.”

So with that said and following Buffet strategy here is our top five dividend stocks for 2016 and beyond:

#5. Cummins Cummins is the world’s largest manufacturer of diesel engines. The company has:

  • 78% market share in mid-duty (MD) diesel truck engines in North America
  • 34% in heavy-duty (HD) diesel truck engines in North America
  • 42% MD & HD market share in truck diesel engines in India
  • 17% MD & HD market share in truck diesel engines in China

Cummins full year 2015 results showed adjusted earnings-per-share of $8.93. This is a slight decline from $9.13 the previous year.

The company is expecting further earnings-per-share declines of between 2% and 10% in 2016 due to general weakness in the diesel engine industry brought about by the global growth slow down and the strong U.S. dollar.

This is great news for investors looking to build a position in Cummins. The company has paid steady or increasing dividends for 25 consecutive years. It must have strong and durable competitive advantage to have dominant market share and such a long dividend streak.

The company’s competitive advantage is its large research and development spending on diesel engines. The company has spent over $2 billion in the last three years on research and development.

The diesel engine industry may not sound like fertile ground for double-digit earnings-per-share growth, but Cummins has managed to grow its earnings-per-share at 11.3% a year over the last decade.

The company will likely manage double-digit earnings-per-share growth over the long-run through further international expansion, purchasing and consolidating its independent distributors, and share repurchases.

 

#4 Flowers Foods  Flowers Foods sells bread and cake products under the following brands (among others)

  • Nature’s Own
  • Wonder
  • Cobblestone
  • Tastykake
  • Dave’s Killer Bread
  • Alpine Valley Bread

The company has a market cap of $3.8 billion and an above average dividend yield of 3.22%. Flowers Foods has paid steady or increasing dividends since 1987. The company’s stability comes from its strong brands in the slow changing bread and cake industries.

Flowers Foods shares have collapsed 40% since highs reached in October of 2015. What is amazing about this collapse is that the company is still growing its earnings-per-share. Flowers Foods grew adjusted earnings-per-share 2.2% in fiscal 2015.

The reason Flowers Foods share price has collapsed is because the company experienced a sales slowdown in the fourth quarter of fiscal 2015. Sales fell 2.2% and earnings-per-share plunged 20% on the quarter. The company was not expecting sales to decline, which resulted in the company failing to control costs and ultimately seeing earnings-per-share decline significantly.

The company is expecting earnings-per-share growth of 6.5% to 13.0% in fiscal 2016. These are not the metrics of a struggling company.

Over the last decade Flowers Foods has compounded earnings-per-share at 11% a year. The company will likely compound earnings-per-share at between 7% and 11% a year going forward. This growth combined with the company’s 3.7% dividend yield gives investors in Flowers Foods expected total returns of 10.7% to 14.7% a year going forward.

 

3. Parker-Hannifin (PH)

Parker-Hannifin is the world’s leading manufacturer of motion and control technologies. The company was founded in 1918 and now has a market cap over $13 billion.

Parker-Hannifin has one of the longest streaks of consecutive dividend payments of any business. The company has paid increasing dividends for 59 consecutive years.

Parker-Hannifin saw its adjusted earnings-per-share decline 17.4% on a constant currency basis in its most recent quarter. The company’s customers are struggling due to low oil prices. This is resulting in fewer sales at Parker-Hannifin. The company’s share price is down over 20% since highs reached in December of 2014.

Parker-Hannifin’s business is cyclical. The company saw earnings-per-share declines when oil prices plummeted in 2009. Despite this the company produces solid long term results. Parker-Hannifin has compounded its earnings-per-share at 8.2% a year over the last decade.

Expect the company to grow earnings-per-share at 7%-to-9% a year over the next decade. This growth combined with the company’s current 2.5% dividend yield gives investors expected returns of 9.5%-to-11.5% a year before valuation multiple changes.

 

2. Abbott Laboratories   Abbott Laboratories is a diversified health care company that manufactures and sells nutrition products, medical devices, diagnostic equipment, and pharmaceuticals.

Abbott Laboratories stock is down 25% versus highs reached in the Summer of 2015. Investors are worried about potential earnings declines from the growth slowdown in emerging markets.

Abbott Laboratories full fiscal 2015 results showed adjusted earnings-per-share growth of $2.15 for the full year, growth of 8.6% versus the previous year. Obviously there is quite a discrepancy between the 25% market decline and 8.6% earnings-per-share growth.

With such a big decline, you’d think Abbott Laboratories announced a horrendous 2016 outlook.

The company is expecting adjusted earnings-per-share of $2.10 to $2.20 in fiscal 2016. Excluding issues in Venezuela from the company’s currency and negative currency effects from the strong United States dollar, Abbott Laboratories is projecting 10% Adjusted earnings-per-share growth. This is far from troubling news — especially considering the poor global economic state.

Abbott Laboratories has paid increasing dividends for 44 consecutive years. The company has invested heavily in emerging markets. The company emphasizes manufacturing its products in the same country in which the products are sold. This reduces currency fluctuation risks and builds connections with communities, companies, and governments. The company also owns many of the most trusted global brands in infant, child, and elderly nutrition.

Abbott Laboratories generates 70% of its revenue in international markets. The company has large operations in several key emerging markets. This international exposure gives Abbott excellent long-term growth prospects as it benefits from faster emerging market growth and global aging populations. The company stands to benefit from China’s lifting of the “one child policy”; this should boost formula sales for Abbott Laboratories over the next several years.

 

1. Archer-Daniels-Midland   Archer-Daniels-Midland was founded in 1902. The company has grown tremendously since that time. Today ADM employs 33,000 people in 140 countries. The company is the largest farm products corporation in the world based on its $20 billion market cap.

ADM’s business is cyclical and is currently in a downturn. The company saw earnings-per-share of $0.61 in its most recent quarter versus $1.00 in the same quarter a year ago. The company’s share price has declined around 35% since highs reached in the summer of 2015.

A downturn in grain prices and oil have caused the company’s stock price and earnings decline. Oil prices effect ADM because the company is a leading producer of ethanol. When oil prices are low, ethanol demand drops. When oil prices are high, ethanol demand rises.

These declines are temporary. ADM’s earnings and stock price will recover when grain and oil prices rise.

ADM’s dividend is safe despite the downturn. The company recently increased its dividend 7%. This is a sign of good faith from management that company’s dividend is not at risk. History is on the company’s side. ADM has increased its dividends for 41 consecutive years. For a company to increase its dividend every year over such a long time period it must have a strong competitive advantage.