No one now knows the fate of President Bush's plan to stop taxing dividends. Yet even if Congress tempers the proposal, investors' renewed interest in dividend-paying stocks is unlikely to blip out. As with most everything on Wall Street, it's all about expectations: With hopes of stock market returns having plunged from the high teens to mid-single digits, stocks with a relatively secure 3% or 4% dividend yield are enjoying a fresh glow.
The question is, which dividend payers are worth putting in your portfolio? There are many approaches to the answer, from trying to isolate those industries with the best chances of growth in earnings and, by extension, dividends, to looking for companies that now pay no dividend but may in the future. But to capture my own list of possibilities, I wanted to cast a wider net. So I started with Value Line's database of 7,849 stocks (available in CD-ROM for Windows or online at valueline.com) and searched it for likely candidates. I wound up with seven (table).
Here's how. First, I asked the software to exclude stocks under $500 million in market value, plus foreign stocks and real estate investment trusts because they don't figure to benefit from the Bush proposal. Next, for a fair range of dividend yields, I spoke to veteran money manager Tony Spare, co-author of a helpful book called Relative Dividend Yield (John Wiley & Sons, $59.95). Stay away from stocks with huge yields, he warned: "If it's 8% or 10%, it's probably not real," meaning the dividend is at risk of being cut. So I set the software to include only stocks yielding between 3%--about what the five-year Treasury note pays--and 6%. Finally, I sought only companies with positive cash flow even after capital spending, with annual dividend growth over the past five years averaging a reasonable 7% or more, and with expected profit and dividend gains this year. After all that, just eight stocks remained standing, including Household International (HI ), which I cut because it's set soon to merge with HSBC.
The rest come from a range of industries. A sluggish grower, ConAgra Foods (CAG ) may see its margins widen as it tilts business further away from commodities and more toward packaged foods, such as its Healthy Choice line. Emerson Electric (EMR ), which makes a slew of gear from industrial valves to kitchen garbage disposals, finished its last fiscal year with a record $1.4 billion in cash flow after capital outlays. General Electric's (GE ) dividend growth has slowed sharply. But Nancy Tengler, Spare's co-author on the first edition of Relative Dividend Yield and CEO of Fremont Investment Advisors, is betting it will rise from 6% lately to perhaps 10%.
After a recent spin-off of several food lines, including StarKist tuna, H.J. Heinz (HNZ ) is cutting debt and refocusing on its mainstays--condiments, frozen foods, and, of course, ketchup. Mailing-services giant Pitney Bowes has paid dividends since 1934. The smallest company on my list, Russ Berrie (RUS ), sells stuffed animals and other gift items. With the recent death of its founder and CEO, the company is being led by director Josh Weston, formerly CEO of Automatic Data Processing. He can rely on a debt-free balance sheet. As for Sonoco Products, the packaging company said it sees cash flow of $140 million to $160 million, after both capital spending and dividends over the next four years.
Will all of these stocks go up? I can't say, but each is in a solid position to maintain and even raise its dividend. At a time when five-year Treasuries pay little more than 3%, that's an alluring offer, dividend tax relief or no.