There are all kinds of reasons to want to invest in safe dividend stocks. Maybe you're a retiree looking for consistent income you can depend on in your golden years. Maybe you just get stressed by watching the stock market bounce around every day and want to know that there's some safety you can depend on.
Regardless, you've come to the right place. But let's start with the core question:
What makes a dividend stock "safe"?
This seems like one question, but it's really two: What makes the dividend payable today safe, and what will ensure its long-term sustainability?
The first is easy to answer: Just take the cash dividend payout ratio (that is, dividends payable for the trailing-12 months divided by free cash flow for the trailing-12 months -- multiplied by 100 to express it as a percentage). Lower is better. If the cash dividend payout ratio is over 80%, that may be a sign that the business will struggle to both pay the dividend and reinvest cash in future business growth. A payout ratio over 100% is a very bad sign, likely signifying that the business is not generating enough cash to maintain the dividend, even if it spends every penny of cash it's earning on the dividend. While the 80% cash dividend payout ratio is a good rule of thumb for most situations, real estate investment trusts (REITs) are required to pay out 90% of their earnings in dividends, which may result in high cash dividend payout ratios without implying a threat to the underlying business.
Image source: Getty Images.
If you're buying a stock for the safety of its dividend, you will want to know that at least that dividend amount (and preferably more) will be around annually for a long time. There is no way to know this conclusively, but there are some good signs that can help you figure it out. The first is history: How long has the company paid a dividend? If the dividend was instituted last year, it's a bit early to know how determined management is to maintain and grow it. If the company is a Dividend Aristocrat, by contrast -- a company that has grown its dividend annually for at least the last 25 years -- then you can feel pretty confident that it's a priority.
The second part is to look forward and think about what management is doing to grow the business. You want to make sure that it's a business that can stand the test of time -- and that management isn't prioritizing today's dividend over tomorrow's growth. Ultimately the business must adapt and succeed if the dividend is to be safe over the long term.
My favorite safe dividend stocks check all of these boxes, and more.
My favorite safe dividend stocks
Something you should be aware of: There is no such thing as a stock that is 100% safe 100% of the time. The nature of business involves risk, and stocks will too. But these are companies I feel pretty darn good about over the long term.
Cash Dividend Payout Ratio
Walgreens Boots Alliance (NASDAQ: WBA)
Johnson & Johnson (NYSE: JNJ)
3M (NYSE: MMM)
Data courtesy of S&P Market Intelligence. Chart by author.
I believe that the past tells us a lot about management's future intentions, and that's why all three of my favorite safe dividend stocks are Dividend Aristocrats. All three also have credible plans to grow and are part of industries with solid tailwinds to fuel their growth. After all, it's tough for a company to grow if it's part of a dying industry. Let's dive a little more into each one to see why they warranted inclusion.
The graying of America
There are two well-known macro reasons why Walgreen Boots Alliance is an attractive investment. The first: 10,000 Americans per day are turning 65 year old from now through 2029. As Americans get older, they're going to need more healthcare. The second: Healthcare is expensive, and becoming more so. As insurers and the government struggle with ways to reduce healthcare costs, they'll increasingly pressure patients to get care in cheaper places where possible -- healthcare clinics, for example, instead of Emergency Rooms.
As the largest retail pharmacy chain in the country, Walgreens is well-positioned to benefit from both trends. Across its roughly 9,500 pharmacies in the U.S. it has roughly 400 healthcare clinics so people can get their immunizations and other inexpensive, outpatient treatments. (While they're there, maybe they'll grab a candy bar or a couple of magazines.)
Its massive retail footprint will only be enhanced by all the pharmacies it's buying from Rite Aid after their failed merger. Walgreens also has significant international exposure with its ownership of over 4,700 retail pharmacies internationally in addition to its U.S. footprint. With U.S. same-store comps growing nicely (a 3.1% year-over-year bump last quarter) and the synergy opportunity with integrating the Rite Aids it's bought, Walgreens has plenty of avenues for further growth.
The next wave of treatments
Johnson & Johnson is another way to play the big incoming increases in healthcare spending. Well, actually, it's three ways to play that growth.
While J&J is best-known for consumer brands like Tylenol and Neutrogena, it actually has three business units: consumer (Tylenol and baby shampoo), pharmaceutical (drugs), and medical devices. And it's doing very well in all three, to the tune of 2.9%, 15.4%, and 7.1% year-over-year revenue growth in each area, respectively. That growth is impressive in and of itself, given that each business turns out more than $12 billion in annual revenue and it gets tough to grow from a big base in competitive markets.
But what's coming next is even more impressive. J&J has several drugs in late-stage trials or in the early days of a big ramp-up in commercialization -- with plenty of potential growth for future years. Blood cancer drug Imbruvica posted 47% year-over-year growth last quarter to an annual run rate of over $2 billion for J&J, but that's a drop in the bucket compared to what the drug could ultimately churn out. J&J shares Imbruvica profits and losses 50/50 with AbbVie. AbbVie's CEO has argued that its share could reach up to $7 billion annually. (While J&J's revenue from Imbruvica won't precisely track with AbbVie's, they should be reasonably close to each other if history is any indicator.) That seemed unlikely even as recently as earlier this year, but Imbruvica was recently approved for its first non-cancer indication -- chronic graft-vs-host-disease -- and has plenty more expansions incoming. That's just one example of the many strong drugs J&J is putting together in its enormous arsenal.
I've focused on Pharmaceutical growth, and for good reason -- Consumer and Medical Devices are the sort of ho-hum businesses that quietly churn out profits and generally post more modest (if any) growth. But they balance out the more volatile drug side, providing J&J with a solid foundation to help keep the dividend safe even if Pharmaceutical (which represents just under 50% of sales) hits the skids. That's really the core of what should keep J&J among the Dividend Aristocrats for years.
More than just sticky notes
Like J&J, 3M is best known for its consumer-facing business (in this case, post-it notes) -- and, just like J&J, there's far more under the hood. In fact, 3M's diversification puts J&J to shame. (And that's saying something.) The company operates in five revenue-generating business segments: industrial, safety and graphics, health care, electronics and energy, and consumer. Industrial is the largest of these, at about twice the size of each of the others, but only represents about 1/3 of total revenue -- giving the company plenty of downside protection as it isn't overreliant on any particular group. Every one of these grew sales year over year last quarter. All but one (consumer) grew operating income year over year last quarter, too. The company's also showing impressive growth abroad as it diversifies away from the core U.S. market, showcasing 13.4% organic sales growth year over year in Asia Pacific last quarter.
I'll briefly highlight the opportunity in industrial, since it is 3M's largest unit, and there are four key growth platforms management has highlighted: automotive (3M provides all kinds of parts to original equipment manufacturers -- or OEMs -- and suppliers), abrasives (which help enable robotic manufacturing), filtration, and structural adhesives. These sound sleepy in theory, and perhaps they are -- but 3M's research and development (where they're boosting spend) can provide the nuts and bolts for broader disruption.
Safety in the present and future
Like I mentioned earlier -- no stock is safe. Businesses change. Management teams make mistakes. The economy shifts. Stuff happens. But these companies have an incredible history of effectively navigating these changes and protecting their dividends, which is why I think they're great investments for anyone looking for safe dividend income.
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