What are we looking for?
Dividend stocks are everyone's favourite investments these days, but obsessing over yields and payout ratios can lead you to miss an important part of the total return picture: growth.
A stock with a modest dividend but a high growth rate can be superior to one that boasts a high dividend but no capacity to expand its earnings. To demonstrate this, we went searching for dividend-paying stocks that also have a demonstrated ability to grow their profits.
How we did it
Craig McGee, senior consultant at Morningstar Canada, scoured the Morningstar database for Canadian and U.S. stocks that pay dividends and are relatively cheap given their growth and dividend rates.
To find promising candidates, he used the PEGY ratio. This consists of each stock's price-to-expected-earnings ratio divided by the sum of its growth rate plus dividend yield. (To determine the growth rate, Mr. McGee used a weighted average of growth over the past five years, expected growth over the upcoming year, and expected growth for the following year.)
He looked for stocks with the best combinations of low PEGY ratios, high expected dividend yields, positive revisions to analysts' earnings expectations over the past 60 days and low earnings variability over the past five years.
To make the cut, a stock had to have:
-a market capitalization greater than $1-billion;
-a PEGY ratio less than 3
-an expected dividend yield greater than 3 per cent;
-a positive 60-day estimate revision;
-a positive five-year earnings growth rate;
-earnings variability in the top 75 per cent of the database.
No more than four stocks from any one sector were included.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its investment research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.
What we found
The 25 U.S. and Canadian companies that made the cut include some names that might not be familiar to you, such as Scana Corp. (a power utility in the southern United States) and Aimia Inc. (a developer of customer loyalty programs).
Of course, you should do your own research before buying any stock. While the firms on this list all appear to possess attractive combinations of dividends and growth, there may be less obvious factors that will affect their investment appeal.