Today’s market can be absolute hell for an income investor.
Interest rates are nonexistent… Short-term bonds don’t yield a damn… Long-term bonds have a big price risk if rates rise… And junk bonds have an even bigger risk in an economic downturn.
Luckily, there’s a select group of companies that continue to make solid income investments in this zero-interest world.
I call them “Heirloom Stocks.”
Based on my calculations, only 80 of these stocks exist in the market today. Better yet, some of them are seriously undervalued right now. And one in particular could deliver double-digit gains.
A History of Excellence
One of the basic tenets of an Heirloom Stock is that the company has a track record of increasing its dividend for 30 years or more – and has plans to continue increasing it for years to come.
You see, the practice of annual dividend increases started in the mid-1950s, when profitability had recovered from the ups and downs of the post-war period.
Companies like the old AT&T (T) telephone monopoly had become favorites of retail investors because of their steady $9-per-share dividends, maintained through the Great Depression. But by the mid-‘50s, shareholders noticed that a flat dividend was losing its value to post-war inflation.
Thus, some companies began giving annual dividend increases to shareholders. One of the best-known dividend growers, Procter and Gamble (PG), began increasing dividends in 1954 and, at 60 years and counting, now has the longest track record of dividend increases.
Of course, many of these dividend growers fell by the wayside in the takeover boom of the late 1960s and the recession of the 1970s. But by the 1980s, it was clear that companies able to increase their dividends annually, even in recessions, were truly superior investments.
As I mentioned, there are now only about 80 U.S. companies with a track record of increasing dividends for 30 years or more. And these companies form excellent permanent investments.
Running on Electric Power
First, their ability to increase dividends every year for several decades indicates that their business is long-term oriented and stable, with the ability to survive recessions without crises. In addition, if the dividend increases are substantial, the yields eventually become juicy – for example, there are several companies paying 10 times their 1994 dividends.
Second, since we can be confident that these companies will continue increasing their dividends, we no longer need to worry about their stock price (except as a chance to buy more). At some point, the increased cash flow to investors will inevitably result in a higher stock value.
Finally, the most important reason to trust these companies is because once they have established a long track record of dividend increases, their managements are loath to break it. They will make extra effort to ensure they can continue paying dividends during recessions and will manage the company for long-term shareholder value. In particular, they won’t goose their stock options by indulging in share buybacks. (Which are a rip-off of small shareholders and normally result in the company buying high and selling low in a recession. Managers are TERRIBLE judges of when the stock is overpriced!)
On top of that, we don’t have to pay a premium for these track records. Many of these companies are trading at a discount to the S&P 500, which is currently at 20 times earnings. If you need further proof, look at the dividend payout ratio, which tells you a company’s ability to survive a setback in earnings.
One especially attractive Heirloom Stock is Emerson Electric (EMR), an electrical equipment company that’s well diversified, with operations all over the globe and more than half of its sales and earnings outside the United States.
Not only has Emerson increased its dividend every year since 1957, it’s also had just three CEOs since 1954. That’s my kind of management continuity… and the current guy is only 59, so he has a few years left yet.
The stock yields 2.7%, with a trailing P/E ratio of 23 times, but a forward P/E ratio of below 16 times. Third-quarter (ended June 30) earnings were triple that of the previous year. Finally, with a quarterly dividend of $0.38 per share, EMR paid out 61% of earnings in the last four quarters, indicating it has room to survive a few bumps in the road.
A yield below 3% may not get you excited, but Emerson’s 20-year return since 1994 is in the double digits. Now that’s an investment to leave your grandchildren!