Many investors are likely familiar with the phrase “buy and hold”. These three words imply that investors should simply buy shares of companies and then hold them through the inevitable ups and downs of the economic cycle. Many believe that this investing strategy could lead to enough wealth creation to last the length of one’s retirement and maybe even allow investors to leave something to their heirs.
In order for this time-tested strategy to succeed, investors must choose sound investments to start with. Investing in low quality stocks and then stubbornly holding on to them when they decline in value likely isn’t a good way to achieve your goals. On the other hand, high-quality stocks have the best chances of providing steady dividend growth and rising passive income.
What is Passive Income?
Passive income can be thought of as money you earn while committing minimal daily effort to maintain. This is different than money you make from your profession. Income from your job can be used to create a retirement portfolio that provides passive income. We believe that the best way for investors to achieve a steady stream of passive income is by purchasing shares of companies that have paid a growing dividend for multiple decades.
In their infancy, publicly traded companies often reinvest every dollar of profit back into the business. Companies in this stage are often experiencing high rates of growth and need all available capital on hand to ensure that they can continue to expand their business and take market share from peers.
Eventually, growth rates decline in many cases, usually because the company has become so large that sustaining high rates of growth becomes harder. Companies in this stage are much more stable, having created a stable customer base or some measure of importance in their given sector of the economy. This quite often leads to increased profitability.
Companies that have raised their dividends through one or more recession have proven that their business model is strong enough to withstand downturns. Past performance does not equate to future success, but a history of growing dividends through adverse economic conditions is a sign of a well-run business.
In our opinion, an excellent place to look for blue chip dividend paying stocks is the Dividend Aristocrat list. Companies that qualify as a Dividend Aristocrat have increased dividends for at least 25 consecutive years, are a member of the S&P 500 index and meet certain size and liquidity requirements.
Membership in this list is so exclusive that just 65 companies currently qualify as a Dividend Aristocrat, showing how difficult it is for companies to achieve the required dividend growth streak.
3 Dividend Stocks For Safe Passive Income
AT&T Inc. (T) has a rich history, dating all the way back to Alexander Graham Bell and the original telephone in the late-1800’s. AT&T isn’t just a phone company though. Today, the company is the largest communications company in the world. Besides offering phone service to customers, AT&T also provides video, broadband, pay-TV and movies.
AT&T is very much a slow growing company these days as earnings-per-share have increased by less than 4% annually since 2011.
That said, the company’s move away from just being a phone company has offered some diversification. The purchase of Time Warner in 2018 gave it an excellent portfolio of content. For example, AT&T recently launch its HBO Max streaming service and had almost 40 million subscribers at the end of January. This is two years ahead of the company’s own expectations.
AT&T is blessed with impressive free cash flow (more than $27.5 billion in 2020). This has allowed the company to more than cover its generous dividend yield of 7%, which is almost five times the average yield of the S&P 500. The company had a free cash flow and earnings-per-share payout ratio of 62% and 65%, respectively, last year, showing that the company is fully capable of supporting its robust dividend. AT&T has raised its dividend for 36 consecutive years.
Another high quality dividend stock is Johnson & Johnson (JNJ), one of the largest companies in the world and a leading healthcare company. The company provides pharmaceuticals, medical devices and consumers products. Johnson & Johnson’s diversified business model allows it access to nearly every area of the healthcare sector.
The company’s business has climbed steadily, with earnings-per-share growing at a 5% clip over the last decade. However, the COVID-19 pandemic was a headwind to results, reducing the decade long growth average by a full percentage point.
Even with the pandemic impacting results, Johnson & Johnson still raised its dividend in 2020, something it has done for 58 consecutive years. This also qualifies Johnson & Johnson as a Dividend King. The company has one of the longest dividend growth streaks in the entire market place and offers a yield of 2.6% today. The earnings payout ratio was just 50% last year and is expected to be just 43% this year, showing that Johnson & Johnson has prudentially managed its dividend growth.
Lastly, Procter & Gamble (PG) is a consumer products giant that sell its products in more than 190 countries. Its core brands include, Gillette, Tide, Charmin, Crest, Pampers, Bounty and Head & Shoulders.
Procter & Gamble has undertaken a drastic scale down over the past few years and has divested non-core assets. The company has a portfolio of 65 brands, down from 170 just a few years ago. Procter & Gamble now has five product categories: fabric and home care, baby, feminine and family care, beauty, health care and grooming, with no one category accounting for more than one-third of total sales.
Having a leadership position in nearly every category that it competes has afforded Procter & Gamble brand loyalty amongst its customer base. Customers trust the products that the company provides, which allows for some pricing power as well.
Brand loyalty is one reason why Procter & Gamble has been able to grow its dividend distribution for 64 years. Few companies have raised their dividend for a longer period of time. Procter & Gamble yields 2.5% and has an expected earnings payout ratio of 56% for 2021.
Final Thoughts
We believe investors can create a retirement portfolio that can provide passive income simply by knowing where to look. The Dividend Aristocrats are a great place to begin the search for passive income as these companies have demonstrated the ability to raise their dividends for at least 25 consecutive years.
An increasing dividend during difficult economic periods is a sign of strength. AT&T, Johnson & Johnson and Procter & Gamble have each accomplished this feat on several occasions. All three companies offer products or services that consumers have come to trust and rely on, even during uncertain times. This has allowed each company to grow dividends even during recessions. Any investor looking to create passive income could do very well owning each of these names.
Written by Nate Parsh for Sure Dividend
Author disclosure: the author maintains a long position in AT&T, Johnson & Johnson and Procter & Gamble.
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