What Dividend Increases Mean for a Stock’s Future

Chris Versace
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Posted: Dec 22, 2014 12:01 AM

The holiday season is ramping up, signaling all sorts of fun and festivities in the days ahead, assuming you can maneuver through the year-end push. Aside from all sorts of economic and industry data points hitting the tape and presents being put under the tree, this time of year tends to see another type of present that can be very helpful to investors.

I’m talking about dividend increases. Next to profits, these are the mother’s milk when it comes to investing. Not only does a company paying dividends provide you, the investor, with income, but the associated dividend yield offers another powerful tool you can use to value the shares. Ask any of my graduate students taking my Equity Analysis class at New Jersey City University, and they will tell you dividend yield analysis is right up there with price-to-earnings and enterprise value to earnings before interest, taxes, depreciation and amortization (better known as EBITDA).

If a company happens to be what I call a “dividend dynamo” and increases its dividend every year, like McCormick & Co. (MKC), Qualcomm (QCOM), Coca-Cola (KO) or PepsiCo (PEP), for example, it means the management team and Board of Directors is confident the company’s cash flow is sufficient to make the payments. It also means a re-valuing of the business based on the size of the annual dividend hike. Companies like these (and others) can see a step function higher in their potential stock price if there are reasons to think historical dividend yield peaks and troughs should apply.

The wildcard, though, is guesstimating the size of the dividend increase. Just like overly bullish earnings forecasts, an overly bullish dividend increase expectation can be like a balloon leaking air if the actual number falls short. And just because a company boosts its dividend doesn’t mean it’s headed to the moon. You still need to check how the shares stack up based on your valuation metrics, including peak and trough dividend yields.

During the last few weeks, a number of companies have bumped up their dividend stream. McCormick & Co. (MKC) recently hiked its annual dividend by 8% to $1.60 per share. During the past few years, MKC shares have peaked and bottomed out at dividend yields of 2.0% and 2.4%, respectively. Applying those yields to the new annual dividend suggests potential upside to $79 and downside to $67. A bigger dividend boost was seen at Disney (DIS), when the House of Mouse and owner of Marvel’s Avengers announced a 34% increase, putting its annual dividend at $1.15 per share. At 1.2%, Disney’s dividend yield is hardly robust when compared to that of the S&P 500, but the increase does put it on more equal footing with Time Warner (TWX) and CBS (CBS). Another big increase was had from payment network company MasterCard (MA) when its board of directors authorized both a 45.5% increase in its quarterly dividend and a new share repurchase program worth $3.75 billion. Some sandbox math reveals the dividend hike equates to a new annual dividend yield of 0.7% for MA shareholders. Again, hardly something to write home about.

Other companies boosting their dividends of late include Boeing Co. (BA), which boosted its quarterly divided by 25% to $0.91 per share and increased its share repurchase plan to $12 billion. Dow Chemical (DOW) is upping its dividend to $0.42 per share from $0.37, the fourth double-digit percentage increase since 2011.

General Electric (GE) raised its annualized dividend by 5% to $0.92 per share. While that sounds like a nice sized raise, comparing it to prior increases, like last year’s 15% increase, we have to wonder what the management team and Board were thinking. Could it be the huge impact in oil or, more likely, the slowing global economy that is in part behind the drop in oil prices?

Speaking of context for dividend payments, a great example can be found with Cedar Fair’s (FUN) dividend. Plain and simple, it has been all over the map during the last few years. As recently as 2011, Cedar Fair’s dividend was a mere $0.08 per share, having plummeted from a high of $0.48 per share prior to the recession. As the economy has come back, so too has Cedar Fair’s dividend, and, yes, this month the company has upped its quarterly dividend by $0.05 per share to $0.75 per share.

Here are some quick things to watch when examining dividend-paying stocks. First, be sure the company is paying quality dividends via cash flow rather than floating debt to pay existing dividends — or worse yet, raise them. Second, check the company’s payout ratio — the ratio of dividends to net income — to gauge if there is room for any additional dividend increases. One dividend dynamo stock that my subscribers have made a killing on is American Water Works (AWK), and its trailing 12-month dividend payout ratio stood at 54.3% according to YCharts. That leaves ample room for more increases ahead.

Dividends are great, but don’t forget options, too

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As you can tell, I am a big fan of dividends, but I’m also a big fan of using options to add some real juice to your portfolio. Consider the current environment of falling oil and renewed concern over the global economy. In that environment, subscribers to my PowerOptions Trader options trading service had the opportunity book an 80% gain in three weeks’ time.

Aside from the potential for big gains, it’s far less expensive to buy an option contract that reflects 100 shares of stock in a company than it is to buy the actual 100 shares. For example, if you bought an options contract for Apple (AAPL) that expired in February, it could cost you $230-$565 dollars plus trading costs — that’s a far cry from the almost $11,000 you would need to buy 100 shares of Apple stock. On the downside, the most you could lose is the amount you spent on the options.

In an upcoming issue of PowerTrend Bulletin, I’ll help you understand the nuances of picking a strike price when you are trading options.

In case you missed it, I encourage you to read my e-letter column from last week about managing risk with stop losses and options.