Any long-term investor can appreciate the value of a dividend. Over time, the dividend becomes a bigger factor in the total return of a company. Mathematically speaking, assume a share of stock is bought for $10 and yields 3%. Five years later the shares trade for $20 and yield the same 3% due to increased dividend payments. For the investor who purchased shares at $10, her effective yield is now 6%. Over the course of 10 years or more, the dividend effect on your portfolio becomes truly significant.
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Dividends do matter but only when they can be counted on to be paid consistently. Often, an abnormally high yield is a market signal that a dividend may be temporary. Yet the market is not always right. During the recession, quality energy master limited partnerships were yielding 15% and up because investors were selling shares as the price of oil and natural gas was declining (dividend yields rise when stock prices decline and vice versa). Yet energy MLPs had hedged production at energy prices that enabled them to maintain distributions. When investors caught on, shares went soaring.
A quality balance sheet, however, is the simplest way to determine the safety and consistency of a dividend. Common stock dividends are paid after bondholders and preferred stockholders. A business with little or no debt is obviously in great shape to continue paying common dividends. (For related reading, see The Power Of Dividend Growth.)
I ran a simple screen looking for profitable stocks that were sporting dividend yields of at least 4%, or double that of the 10-year US Treasury yield. In addition, I only screened for stocks whose balance sheet showed a cash balance that was equal to or greater than the debt balance. Meridian Bioscience (Nasdaq:VIVO), a maker of diagnostic test kits used in lab tests currently yields 4.4%. The company boasts a market cap of $698 million, no debt and $25 million in cash.
PetMed Express (Nasdaq:PETS), an online seller of pet care products, boasts a yield of 5.2% and a cash-rich balance sheet to go with it. The company is debt free and cash per share is nearly $3 against a stock price of $10. Terra Nitrogen (NYSE:TNH) is a limited partnership that sells and markets nitrogen fertilizer products to agricultural customers. Shares yield almost 8% and the company is benefiting from the favorable outlook for agricultural commodities. Homeowners Choice (NYSE:HCII) is a small Florida insurance business that certainly appears cheap from various angles. Shares yield 6.4%, and at $6 a share, they are well below the book value of $9.51 a share.
The Bottom Line - Buyer Beware
One of the reasons the above businesses exhibit such attractive yields is the share price has declined in 2011 thereby increasing the yield. None of the businesses are facing any significant issues so today could present a decent entry point. But of course, dividends don't mean much if you buy a business with a poor long-term future. (For related reading, see Digging Into The Dividend Discount Model.)
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