U.S. Markets open in 7 hrs 50 mins

How to Find Dividend Stars in 10 Sectors

Carla Fried

While your grandparents may have limited their dividend investing to the classic slow-growth/high-income utility and telecom sectors, Richard Skaggs, chief investment strategist at Loomis Sayles pointed out in a recent investment note that it’s never been easier to build a diversified portfolio of dividend payers. Within the S&P 500, 240 stocks across all 10 sectors have a current yield of at least 2%. From Intel’s (INTC) 4.2% dividend yield in the dividend rich Technology sector to Consumer Staple standouts such as Johnson & Johnson (JNJ), 3% dividend yield, no sector today is a dividend desert.

There are also plenty of dividend growth standouts. While the average growth rate for the past 20 years has been 4.7%, Skaggs notes that sectors such as Consumer Staples, Consumer Discretionary and Health Care have strong 8-9% five-year dividend growth rates.

And he makes the case that in the aggregate there’s plenty of reason to expect strong dividend growth to continue. Given high corporate cash levels and an increasing focus on management returning capital to shareholders (both in dividends and buybacks) Loomis Sayles says it would be “reasonable” for the dividend payout ratio to rise from today’s 32% closer to its 20-year average in the high 30% range. In fact dividends could be a bigger piece of the return pie: “Since we are mid-business cycle, we believe that dividends may grow faster than earnings for the next few years, assuming business conditions remain constructive,” wrote Skaggs.

Using YChart Stock Screener it’s easy to dissect the dividend stars within each sector. On the left side of the screen under “start with” choose “Indexes”, then choose “S&P 500”. From there, YCharts Pro subscribers can choose “Intersect” and pick a sector of the S&P 500 to drill down into. Once that’s set, you can add Filters to do some strategic sifting to find the most compelling prospects.

We’re going to tackle all 10 sectors in a Ycharts series. Each sector will be winnowed down by adding a filter that requires a stock to have at least a 2% current yield and a five-year dividend growth rate that is at or above the average for its sector. We’re also going to require that the estimated forward PE ratio comes in at or below the sector’s average (we’re using S&P Capital IQ 2013 estimates). A company delivering above average yield, above average dividend growth and selling at a below average valuation is a good place to start further investigation.

Let’s start with the health care sector. Its 15.2% price gain in the first quarter was the strongest sector showing within the S&P 500. YChart Stock Screener, there are 12 stocks with dividend yields of at least 2%. From there, adding in a five-year 8% annualized dividend-growth-rate filter and requiring a forward PE ratio below 14.7 narrowed our list to just three stocks: Cardinal Health (CAH), Medtronic (MDT) and Merck (MRK). Medtronic, among the S&P 500 Dividend Aristocrats, has one of the best records of dividend growth.

Merck’s 3.8% current dividend yield is more than a percentage point above the other two, but it’s not as if Merck has a track record of consistently raising its dividend; it idled on the payout for more than three years after the financial crisis.

MRK Dividend Chart

And with a dividend payout ratio around 80%, income investors have to wonder how aggressive Merck’s dividend growth can be going forward. Cardinal Health’s payout is 27% and Medtronic is at 30%.

Moreover, Merck’s trailing PE ratio suggests it is anything but a bargain.

MRK PE Ratio TTM Chart

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

More From YCharts