Today’s post is from Bob Ciura of Sure Dividend, one of the internet’s premier dividend investing sites, with his recommendations for retirement income.
Income investors strive to build a portfolio that will secure a reliable and growing income stream for their retirement phase. In the past, most investors used to reduce their exposure to stocks in favor of bonds as they approached their retirement in order to avoid the volatility related to the stock market.
However, as the yields of bonds have remained depressed for more than a decade, that strategy does not work anymore. Therefore, investors should shift their focus on Dividend Aristocrats in order to secure passive income for their retirement. In this article, we will analyze the advantages of high-quality dividend growth stocks such as the Dividend Aristocrats.
Durable Competitive Advantage
Dividend Aristocrats are the group of S&P 500 stocks that have raised their dividends for at least 25 consecutive years. In order to achieve such an exceptional dividend growth streak, companies should have a durable competitive advantage. Indeed, most Dividend Aristocrats have exceptional brand strength or operate in niche markets, where they enjoy a dominant position thanks to weak competition.
Thanks to their strong business models, Dividend Aristocrats need to spend minimal amounts to defend their market share. As a result, they generate excessive free cash flows. As dividends and share repurchases are funded from free cash flows, the excessive free cash flows of Dividend Aristocrats are paramount to income investors.
Investors looking for stable passive income should avoid companies which spend most of their earnings just to remain relevant or pay for their maintenance expenses. This group of companies includes auto manufacturers, airlines and other highly cyclical companies. Instead, investors should select companies which have ample cash flows available for shareholder distributions.
Resilience to Recessions
Resilience to recessions is also of high importance to income investors such as retirees. When the value of a portfolio plunges during the retirement phase, the retiree goes through extreme psychological pressure due to uncertainty. It is thus critical that retirees have selected stocks that are resilient to recessions and can continue to pay (and even raise) their payouts in economic downturns.
Dividend Aristocrats have repeatedly proved that they are among the most resilient stocks to recessions and bear markets. As a multi-decade period includes severe recessions, such as the Great Recession in 2009 and the recession caused by the pandemic last year, Dividend Aristocrats have proved the robust nature of their business models.
Their defensive nature also makes it easier for investors to endure bear markets without selling their holdings at the worst time. During bear markets, capital gains of years may evaporate in just a few weeks but Dividend Aristocrats continue to offer a growing income stream to their shareholders. As a result, the latter can wait patiently until the bear market comes to an end and the subsequent recovery shows up. This is not the case for the shareholders of stocks with minimal dividends.
Passive Income
Investors should build a portfolio that will generate a passive income stream in their retirement phase. If they invest in cyclical companies or companies that operate in highly competitive markets, they will have to monitor their holdings closely and change the composition of their portfolio on a regular basis. This is certainly a recipe for disaster for retirees.
Instead, investors should focus on companies which have robust business models and thus offer reliable and growing distributions to their shareholders. Dividend Aristocrats certainly meet these criteria.
Johnson & Johnson (JNJ)
Johnson & Johnson is a high-quality Dividend King, which has raised its dividend for 59 consecutive years. Most investors know the company for its consumer products but the pharmaceutical segment is by far the most profitable segment of the company, as it generates approximately half of the total revenues and 75% of the earnings of the company.
Moreover, Johnson & Johnson has 28 brands/pharmaceutical platforms that generate more than $1B in annual revenues. The company is a dominant player in its markets, as it generates approximately 70% of its sales from the #1 or #2 market share position. Moreover, it generates about 25% of its sales from products launched in the past five years. This is certainly impressive, particularly for a relatively mature company that has a market cap of $450 billion, and confirms that the company never rests on its laurels.
Johnson & Johnson is currently offering just a 2.5% dividend yield. However, it has a healthy payout ratio of only 45% and a rock-solid balance sheet. As it has returned to its growth trajectory this year, investors can rest assured that this pharmaceutical giant will continue raising its dividend for many more years. Given also its resilience to recessions, Johnson & Johnson is a great candidate for the portfolios of income-oriented investors.
3M Company (MMM)
3M has paid a dividend for more than 100 consecutive years and has raised its dividend for 62 consecutive years. This is a very rare record, as only 7 other companies have achieved such long dividend growth streaks.
3M is a diversified global manufacturer, which sells more than 60,000 products in more than 200 countries. Its products are used every day at home, in hospitals, office buildings and schools. As 3M is an industrial manufacturer, most investors would expect the company to be cyclical and vulnerable to recessions.
However, this is not the case. 3M spends hefty amounts on research and development every year. The company has set a goal to spend approximately 6% of its revenues on R&D so it has spent $1.7-$1.8 billion per year on R&D in each of the last eight years. Thanks to this strategy, 3M has easily maintained its pioneering character and has secured more than 100,000 patents. It has thus built a durable competitive advantage in its business, which is the key factor behind the exceptional growth record of the company and its resilience to recessions.
3M is currently offering a 2.9% dividend yield, which is more than twice as much as the 1.4% dividend yield of the S&P 500. In addition, 3M has a healthy payout ratio of 63% and a rock-solid balance sheet, as its net debt of $24.5 billion is only 20% of the market capitalization of the stock and less than five times its annual earnings. As a result, 3M will easily continue raising its dividend for many more years.
Notably, 3M has grown its dividend at a 10.7% average annual rate over the last decade, though it has somewhat decelerated in recent years, with 7.1% average growth over the last five years. The current payout ratio is healthy but it is at the upper part of the historical 10-year range 37%-67% of the company. As the company is likely to grow its earnings per share at a mid-single digit rate in the upcoming years, investors can reasonably expect 3M to grow its dividend by about 5% per year on average in the upcoming years.
Procter & Gamble (PG)
Procter & Gamble is a consumer products giant that sells its products in more than 180 countries and generates approximately $75 billion in annual revenues. Notable brands include Pampers, Luvs, Tide, Gain, Bounty, Charmin, Puffs, Gillette and Head & Shoulders. Procter & Gamble has raised its dividend for 65 consecutive years and thus it is a Dividend King, with one of the longest dividend growth streaks in the investing universe.
In recent years, Procter & Gamble implemented a drastic restructuring program, which included the divestment of nearly two-thirds of the brands. The company divested the slow-growth, low-margin products while it maintained the ones with the most promising growth potential and highest margins. In this way, management was able to focus much more efficiently on the most potent brands and thus the consumer stalwart has returned to its multi-decade growth trajectory in the last five years.
Moreover, Procter & Gamble has benefited from the coronavirus crisis, which has provided a strong boost in the sales of home care and hygiene products. This tailwind has more than offset the negative effect of the pandemic on the consumption of products related to personal care. As a result, the company achieved record earnings last year and is on track for another record this year.
Procter & Gamble is currently offering a 2.5% dividend yield. Thanks to its healthy payout ratio of 61%, its strong balance sheet and its decent growth prospects, the company will easily continue raising its dividend for many more years. Given also its resilience to recessions, Procter & Gamble is a great candidate for income-oriented investors, though the latter should probably wait for a correction of the stock due to its current rich valuation.
Final thoughts
Income investors should build a portfolio that will generate a reliable and growing income stream for their retirement. The portfolio should also be resilient to recessions and bear markets and should have the minimum possible volatility in order to save investors from emotional pain and potential detrimental investing decisions. Dividend Aristocrats fit all these criteria and as a result, they are ideal for generating passive income for retirement.
About Bob Ciura
Bob Ciura has worked at Sure Dividend since October 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. Bob received a Bachelor’s degree in Finance from DePaul University, and an MBA with a concentration in Investments from the University of Notre Dame.
What is your investment approach? You let me know here.
This article is for informational purposes only and is not investment advice. Past performance is no guarantee of future results.
The post How Dividend Stocks Can Provide Passive Income For Retirement appeared first in Smile If You Dare.