Growing Your Income

8/1/2016


Growth matters, and we all know it, even if we don't realize we know.

Picture yourself as a recent college graduate diving into the work world. After an extensive job hunt, you receive two offers:

• Company A offers you an entry-level job paying $25,000 per year, with opportunities for advancement if you prove yourself.

• Company B offers you a similar job paying $50,000 per year, but only if you commit to work there for 20 years at that salary.

Which job is better?

While both offers have appeal, graduates with confidence in their ability should probably accept the first offer because it allows the potential for higher income over time and doesn't cap their earnings power. To double your earnings in 20 years, your pay must rise at an annualized rate of 3.5% over that time, a pace that smart, competent workers can exceed by being promoted up the ranks.

Now picture yourself as an investor choosing between two stocks:

• Company A yields 4% but generates no earnings growth, so the dividend will likely remain constant.

• Company B yields 2% but has a history of strong dividend growth.

The investors face a different scenario than the entry-level worker, but a similar choice. Regular readers know which option we typically select — the one with dividend-growth potential.

The table below demonstrates that higher-yielding stocks tend to earn lower Quadrix Overall scores, while stocks with dividend growth enjoy higher scores. The stronger the dividend growth, the higher the Overall score. Not surprisingly, the Forecasts gravitates toward stocks with dividend growth.

ANALYZING INCOME CHARACTERISTICS
Among stocks in the S&P 1500 Index of large, medium-size, and small stocks, those with strong dividend growth tend to earn stronger Quadrix Overall scores; the higher the growth, the higher the Overall score. In contrast, Quadrix scores tend to decline as dividend yield rises. All of the numbers below are averages for stocks with different characteristics.
Dividend Growth
(Annualized)
----------------- Quadrix Scores -----------------
Group (Number Of Companies)
Div.
Yield
(%)
3
Years
(%)
5
Years
(%)
Div.
Yield
3-Year
Dividend
Growth
5-Year
Dividend
Growth
Overall
All S&P 1500
stocks (1,500)
1.6
6
11
57
57
59
59
Dividend payers (999)
2.4
10
14
72
59
61
59
Nonpayers (501)
0.0
NM
NM
26
9
10
58
Quadrix individual factor scores above 80
Dividend yield (269)
4.2
9
12
87
56
58
55
3-year growth (208)
2.3
34
32
71
90
84
65
5-year growth (215)
2.4
20
37
73
75
90
66
Dividend yield
Above 1% (855)
2.7
11
14
75
61
62
59
Above 2% (549)
3.3
10
13
81
59
60
56
Above 3% (257)
4.3
9
11
87
55
57
54
Above 4% (111)
5.5
9
14
91
54
56
52
Three-year dividend growth
Above 5% (559)
2.4
19
20
72
74
73
61
Above 10% (384)
2.3
24
25
71
81
79
64
Above 20% (165)
2.4
37
35
72
90
85
67
Yield and growth
2% yield, 5%
growth (316)
3.2
18
19
80
73
72
58
2% yield, 10%
growth (199)
3.2
25
26
80
81
79
62
2% yield, 20%
growth (85)
3.4
39
36
81
90
85
64
Notes: Quadrix scores are percentile ranks, with 100 the best. NM Not meaningful.

S&P 1500 Index stocks with three-year annualized dividend growth above 20% average Overall scores of 67. Screening out stocks with yields of 2% or lower leaves us with 85 stocks, which average Overall scores of 64. Visit www.DowTheory.com/Go/GrowYield for a list of those stocks. The table below presents the seven stocks from that group that earn A ratings on our Monitored List, and two are profiled below:

Helped by acquisitions, AbbVie ($65; ABBV) has delivered excellent growth — sales up 16% and per-share profits 39% in the 12 months ended March. The company expects to launch 20 new products or indications for existing drugs through 2020, generating $30 billion in peak annual revenue. While those numbers sound too good to be true, the pipeline is impressive by any measure. Unfortunately, riches will take time to flow through that pipeline, leaving AbbVie vulnerable to attacks on its patent for Humira, which generates 60% of the company's sales.

Humira treats everything from rheumatoid arthritis to Crohn's disease to colitis, and AbbVie continues to research new applications for the wonder drug. While AbbVie says it expects Humira to retain patent protection until 2022, some patents expire in 2016 and 2018, and rivals are already lining up to grab for a piece of the pie. AbbVie is rated A (above average); dependence on a single product is one reason it does not qualify for our recommended lists.


Electronic-device giant Apple ($103; AAPL) has only paid a dividend for four years. However, in the 12 months ended March it paid out $11.89 billion in dividends, good for second place among U.S. stocks, behind only Exxon Mobil ($91; XOM). Apple's cash flows have eroded over the last year, but the company still generated free cash flow of $38.8 billion in the year ended June, leaving plenty of room for more dividend hikes.

In the June quarter, Apple earned $1.42 per share, down 23% yet topping the consensus by $0.03. Revenue fell nearly 15% to $42.4 billion but also exceeded expectations. The company sold $24.0 billion in iPhones, down 23%. The 40.4 million devices sold in the quarter beat the market's target of 40 million. iPad sales rose 7% to $4.9 billion, the strongest growth in 10 quarters, helped by the pricier iPad Pro. Apple issued encouraging September-quarter guidance, projecting revenue of $45.5 billion to $47.5 billion, versus the $45.7 billion consensus. Shares of Apple, which returned more than $13 billion to investors through share buybacks and dividends in the quarter, rose on the news. The stock is a Buy and a Long-Term Buy.

YIELD AND GROWTH PICKS
The seven stocks below yield at least 2% and have grown their dividends at an annualized rate of 20% over the last three years. All are rated A (above average) in our Monitored List, with those in bold also on our buy lists.
5-Year
Average
Yield
(%)
--- Dividend Growth ---
-- Annualized --
--------------- Quadrix Scores ---------------
Company (Price; Ticker)
Div.
($)
Yield
(%)
1
Year
(%)
3
Years
(%)
5
Years
(%)
Div.
Yield
3-Year
Dividend
Growth
5-Year
Dividend Growth
Overall
Sector
AbbVie ($65; ABBV)
2.28
3.5
3.1
20
74
25
85
87
87
91
Health care
Amgen ($171; AMGN)
4.00
2.3
1.8
29
30
NA
75
90
NA
94
Health care
Apple ($103; AAPL)
2.28
2.2
1.6
11
22
NA
73
85
NA
73
Technology
Boeing ($136; BA)
4.36
3.2
2.4
23
28
17
83
89
79
96
Industrials
EQT Midstream
Partners ($76; EQM)
2.98
3.9
2.7
23
56
86
87
95
99
98
Energy
Ford Motor ($14; F)
0.60
4.3
2.7
62
50
NA
90
94
NA
96
Discretionary
Home Depot ($136; HD)
2.76
2.0
2.1
23
25
21
70
87
82
79
Discretionary
Note: Quadrix scores are percentile ranks, with 100 the best.Ā  NA Not available.

 


Can growth diversify an income portfolio?

Investors who only buy dividend stocks must fish in a different pond than the rest of us. That pond features a higher percentage of financial, industrials, materials, and utility stocks than the broad S&P 1500 Index, with a smaller percentage of energy, health care, and technology stocks.

Jack up your requirements to a 2% yield, and the selection of fish changes again. Financials and utilities make up nearly half of this group, while health care, industrials, and technology, which combine to account for 41% of index stocks and 33% of dividend-payers, comprise just 22% of the high-yielders.

We have long warned investors not to concentrate portfolios too heavily in any sector, a tough task if you select stocks based solely on yield. A representative portfolio of 2% yielders would underweight many key growth sectors.

Within that group of high-yield stocks, we wondered whether limiting our selections to stocks with strong dividend growth would provide a more diverse portfolio. With that in mind, we screened out all the stocks with less than 20% annualized dividend growth over the last three years. A peek at that yield-and-growth portfolio revealed the following:

• The proportion of financials barely changed, and they still accounted for nearly 40% of all stocks in that high-yield, high-growth group.

• A growth screen eliminated all but one consumer-staples stock and all but two utilities. Those two sectors account for less than 4% of the yield-and-growth portfolio, way down from their combined 14% of the yield-driven portfolio.

• Consumer-discretionary stocks account for 17% of the yield-and-growth portfolio, up from 14% of the yield-driven portfolio. The proportion of energy stocks more than doubled to 13%.

Conclusion: Adding a growth component to a high-yield portfolio won't improve overall diversification. In our yield-and-growth portfolio, five sectors combined to account for just 13% of the stocks.

However, income-oriented investors who seek out dividend growth as well as yield should end up with a portfolio weighted somewhat higher in economically sensitive growth stocks than those who focus solely on yield.


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