Saturday, October 28, 2006

Dividends as an Approach to Selecting Stock Investments

One method to use in selecting equity investments is to focus on a company's dividend practice. With dividend growth stocks, a company's board of directors (BOD) know its investors tend to own the stock in part to collect an ever growing dividend or income stream. A company's BOD will strive to maintain the dividend growth rate even when business may be weakening. This desire to maintain the dividend growth will force other company financial measures to deviate from normal levels when business may be weakening. Over time, a company's long run stock return tends to match its long term dividend growth rate, all else being equal.

Ideally, one would want to invest in a company that increases its dividend at least every fifth quarter. Additionally, the dividend yield should be at such a level, say greater than 1%, that any change in the dividend growth rate is significant enough to have an impact on a company's balance sheet and cash flow.

An example would be Aflac (ticker AFL). The company reported earnings on 10/24/2006 that were lower than the same quarter a year earlier. However, if one looks at AFL's 3rd quarter 2006 operating earnings, they were up 9.1% compared to the 3rd quarter of 2005. One reason cited for the lower earnings was the impact of a stronger US Dollar versus the Yen. Nearly 75% of AFL's revenue and earnings are generated from the company's Japanese business segment. Looking forward, the markets project the US Dollar will weaken against the Yen (Yen Chart). A weaker US Dollar will enhance AFL's earnings as the Yen is converted to US Dollars for financial reporting purposes. From a dividend perspective, AFL increased its 4th quarter dividend to 16 cents a share versus 11 cents a share in the same quarter a year earlier. The company also stated they were increasing the 1st quarter 2007 dividend to 18.5 cents per share versus 13 cents a share in the 1st quarter of 2006. Is this an indication that the company anticipates improving business going forward?

AFL Dividends per Share ($)

2002 2003 2004 2005 2006 2007

March 0.05 0.07 0.095 0.11 0.13 0.185

June 0.06 0.07 0.095 0.11 0.13

Sept. 0.06 0.08 0.095 0.11 0.13

Dec. 0.06 0.08 0.095 0.11 0.16

AFL Dividends per Share YOY Comparison

2002 2003 2004 2005 2006 2007
March 18% 40% 36% 16% 18% 42%
June 20% 17% 36% 16% 18%
Sept. 20% 33% 19% 16% 18%
Dec. 20% 33% 19% 16% 45%

The 5-Year dividend growth rate for AFL is 22%. An item to watch is the payout ratio. The company's payout ratio has increased from 15% in 2002 to 19% in 2006. Annualizing the 18.5 cent 1st quarter dividend results in a 2007 projected payout ratio of 22% for the year 2007.

From a stock price perspective, based on Friday's closing price of $45.08, the stock is trading approximately 9% below its 52-week high of $49.65 and approximately 6% above its 52-week low of $42.41.

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