Dividend Growth Index – My Picks Explained

The Dividend Growth Index was a project that started last week by Mike over at The Dividend Guy Blog and involves a total of eight bloggers who picked three stocks each for a total of 24 stocks. I’m writing this article today to explain my three stock choices for the index. I’m pretty excited about my picks and this index as a whole. This is going to be a fun, long-term project that shows readers the power of compounded dividends as well as the resilient nature of strong dividend paying companies.

A quick note before I begin: Dividend Growth Investor has joined this project, and we’re all extremely excited to have this esteemed investor and blogger involved. Dividend Growth Investor is one of the most popular dividend growth oriented blogs available on the internet and he’s extremely knowledgeable on this subject. He puts his money where his mouth is and invests a lot of his hard-earned money in the stocks he continually recommends. His three picks are as follows:

Chevron (CVX:US)
McDonald’s (MCD:US)
Enterprise Products Partners L.P. (EPD:US)

Again, I’m writing this article today to explain my three picks. I have around 50 or so stocks that I continually monitor on my watchlist, including the 18 I am currently invested in. In that regard, it’s terribly difficult to pick just three. But, when picking just three I tried my best to manage diversification and risk. My three picks are in completely different sectors and industries and are correlated to different parts of the economy. They have different risk profiles and offer limited downside and a lot of upside potential. I also put my money where my mouth is and I have regularly invested with all three stocks I picked for the index.

I’ll present each pick, along with the reasons I picked it. I’m also going to include basic metrics including price information and dividend information.

Philip Morris International Inc. (PM)

Philip Morris International is the world’s second largest tobacco company, behind only China National Tobacco. I’ve analyzed this company and feel it’s a compelling buy. It has a wide economic moat due to the scalability of its operations, the dominance in most available markets and the addictive nature of its products. Its flagship brand, Marlboro, is very well-known and people pay up to have this brand. I feel there is a lot of growth available for PM in the future. In developing countries, where consumers are hungry for western amenities like fast food, cars, energy consumption and cigarettes, the cost of tobacco is still relatively cheap compared to what it costs here. As GDP rises in some of these countries, the price of tobacco will rise as well. PM shareholders will reap this reward.

I think PM offers limited downside risk as global tobacco consumption is likely not going to abate anytime very soon. I think this company offers great medium-term growth prospects. The entry yield is very solid, the payout ratio is under control and the upside potential is outstanding, in my opinion. Some risks include government litigation, which will vary by country. You also experience currency risk with PM, as its earnings are all outside the U.S.

Key Metrics:

P/E: 14.1
P/CF: 10.6
P/S: 3.9
P/B: 29.6

Dividend Yield: 4.99%
5-year Dividend Growth: N/A*
Most Recent Dividend Raise: 20.3%
Payout Ratio: 70.4%

5-Year EPS Growth: N/A*
5-Year Revenue Growth: N/A*

*PM was spun off from Altria Group (MO) in 2008.

ConocoPhillips (COP)

ConocoPhillips is an international integrated energy company. I feel the world’s energy demand is not going to decrease anytime soon. The available supply of oil is only getting smaller as Earth isn’t producing any more of it. The natural laws of supply and demand indicate to me that as demand increases from developing countries and emerging markets and supply decreases as the available sources of oil dwindle, the price will only increase. I don’t have any idea if we are close to peak oil, or if we already hit it. I do know that oil is a product that people will continue to need until a replacement energy source is cheap and abundant. I don’t think this will happen soon, so I continue to invest in Big Oil.

I believe ConocoPhillips provides solid medium-term investment potential. It has a great entry yield with a low payout ratio. The dividend has been growing significantly and is very sustainable. In addition, the upcoming split of ConocoPhillips into two separate companies, one concentrated on exploration and production and the other on refining and marketing, promises to create additional shareholder value, with one company continuing to pay the current dividend and the second company paying its own dividend. I look forward to seeing how this all pans out. The risks of investing in COP are directly related to the swings in the price of oil. As a commodity, its value trades up and down regularly, as its tied to complicated futures and politics. Long-term, however, I think there is a lot of value in this company. Another risk may be the short-term weight on the share price as some investors wait on the sidelines until the split is complete.

Key Metrics:

P/E: 7.7
P/CF: 4.6
P/S: 0.4
P/B: 1.2

Dividend Yield: 4.33%
5-year Dividend Growth: 12.7%
Most Recent Dividend Raise: 15.3%
Payout Ratio: 33%

5-Year EPS Growth: -19.44% (compounded annually)
5-Year Revenue Growth: -0.84% (compounded annually)

The Procter & Gamble Company (PG)

Procter & Gamble is the world’s largest consumer product manufacturer. It’s about as solid as dividend growth stocks go, with 55 years of dividend growth. This is my “safe” pick of the three, as tobacco and oil are prone to swings in the economy, but people need to wash, shave and wipe themselves no matter what. Even if you’re unemployed you have to shower and clean yourself! I don’t have to say a lot about this pick. It’s fairly safe, as far as equities are concerned and is a pretty solid pick, in my opinion. It offers a pretty decent entry yield, rock-solid growth history and an enviable product lineup. I think there is limited downside at the current prices, but probably not a large catalyst to propel it upwards. That’s OK to me, as that provides an opportunity to build my position at a fair price.

There are risks with PG, just like any other company. Rising commodity costs, including paper are always something to be concerned about. If consumers are really squeezed at their margins, they can always go to store brand consumer products. I think the risk of consumers downtrading might be a little limited. I’m an extremely frugal person, but I still buy Charmin toilet paper and Gillette razors because I feel they are superior products. I’ve tried the store brands, and I think most people would agree. It’s because of their superior products, or in some cases the illusion of such, that they have grown into such a large brand.

Key Metrics:

P/E: 16.0
P/CF: 14.2
P/S: 2.3
P/B: 2.6

Dividend Yield: 3.34%
5-Year Dividend Growth: 11.6%
Most Recent Dividend Raise: 9%
Payout Ratio: 53%

5-Year EPS Growth: 8.28% (compounded annually)
5-Year Revenue Growth: 3.89% (compounded annually)

I hope my three picks add solid risk-adjusted returns for the index with a large margin of safety. I’m excited to see how my picks, as well as the other 21 stocks do over the long-term.

The blogs involved in the Dividend Growth Index:

The Dividend Guy
Dividend Monk
Dividend Ninja
My Own Advisor
The Wealthy Canadian
The Passive Income Earner
Dividend Mantra
Dividend Growth Investor

Full Disclosure: I’m long COP, PM, PG, CVX, MCD

Thanks for reading.