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5 Dividend Growers to Watch

Which is more important to an income investor – current dividend yield or future yield on cost?  The typical answer is – it depends.  My answer would be to have a portfolio of stocks that can provide both, current yield and growing dividends.  This is what I evaluate when I am looking at dividend stocks.  In addition, I use my valuation model to get an idea of what to expect in the next 10 years. Of course, the model only provides projections based on what is expected of the stock using its current growth rates.  Therefore, I update these estimates as the market evolves to determine what has changed that will affect my outlook of the stock.  This will tell me when to add or exit the position.  Here are 5 stocks I have evaluated based on the current market conditions.

Raytheon Company (RTN) designs, develops, manufactures, integrates, and supports technological products, services, and solutions for governmental and commercial customers in the United States and internationally.  RTN is currently trading at $50.36, 10% below its fair value.  RTN has an equity summary score of 9.4 of 10 indicating analysts are very bullish on this stock.  RTN has a current dividend yield of 3.4% with a dividend growth rate of 12%.  Looking
forward 10 years, RTN will have a yield on cost of 10.9%.

RTN had Q4 EPS of $1.58, vs. $1.37, which is above the $1.35 estimate, on higher operating margins than we expected.  Orders for 2011 rose 9% and book-to-bill was 1.1X.  Nevertheless, we see risk in potential defense budget “sequestration” and other budget cuts.  RTN will have a higher tax rate in 2012 and
will have gains from share repurchases through 2013. RTN has a target price of $55, on our view of RTN’s ability to maintain profitability despite a difficult
defense environment.  RTN Shares should be HOLD until more certainty regarding the defense cuts outlook.

Cardinal Health, Inc. (CAH) operates as a healthcare services company that provides pharmaceutical and medical products and services. The company operates in two segments, Pharmaceutical and Medical.  CAH is currently trading at $41.54, which is significantly below its fair value.  CAH has an equity summary score of 9.3 of 10 indicating analysts are very bullish on this stock.  CAH has a current dividend yield of 2.1% with a dividend growth rate of 12%.  Looking forward 10 years, CAH will have a yield on cost of 6.4% with a payout ratio of 27%.

CAH had Q2 FY 2012 non-GAAP EPS that climbed 11% to $0.81, beating the estimate by $0.02. The key Q2 driver was a 30% profit gain from drug distribution, reflecting internal growth, acquisitions and better margins.  However, medical products profits fell 18%, impacted by residual commodity cost
pressures. Looking to second half FY 2012, CAH will see continued double-digit EPS growth, lifted by expansion in higher-margin generics and greater
contributions from acquisitions. Based on its EPs growth and cheap market valuation, CAH should be a BUY.

Lockheed Martin Corporation (LMT) engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the United States and internationally. LMT is currently trading at $88.29, which is 17% above its fair value.  LMT has an
equity summary score of 9.2 of 10 indicating analysts are very bullish on this stock.  LMT has a current dividend yield of 4.6% with a dividend growth rate of 12%.   Looking forward 10 years, LMT will have an impressive yield on cost of 14.1% if it reaches a payout ratio of 70%.

LMT had Q4 EPS of $2.14, vs. $2.28, above the $2.01 estimate. Sales fell 4% as operating margins rose 20 bps, to 8.9%, better than expected. We note F-35 low-rate production is being slowed by Pentagon, although LMT expects F-35 growth in 2012. Backlog rose 3%, year to year. We see mixed US govt. budget effects on LMT, with backlog up for Aeronautics and Electronics, but down for IS&GS and Space Systems. Based on defense cuts and overpriced stock, LMT should be a HOLD until the stocks pulls back to fair value.

Occidental Petroleum Corporation (OXY) operates as an oil and gas exploration and production company primarily in the United States. The company operates in three segments: Oil and Gas; Chemical; and Midstream, Marketing, and Other.  OXY is currently trading at $104.67, which is significantly below its fair value.  OXY has an equity summary score of 9.1 of 10 indicating analysts are very bullish on this stock.  OXY has a current dividend yield of 2.1% with a dividend growth rate of 10%.  Looking forward 10 years, OXY will have a yield on cost of 5.4%.

OXY had Q4 EPS of $2.02, vs. $1.49, beating the estimate by $0.19 on revenue from strong oil realizations. OXY lifted production 4% in 2011 as U.S. offset shut-ins in Libya and from production sharing contracts. Growth resulted from a ramp in Permian and California. U.S. is a key growth factor, offsetting issues in Libya and Yemen. OXY will have production up 6% in 2012 and 8% in 2013, on California. These shares should be a long-term BUY based on outlook and valuation.

Alliance Holdings GP, L.P (AHGP) produces and markets coal primarily to utilities and industrial users in the United States. It produces a range of steam coal with varying sulfur and heat contents.  AHPG is currently trading at $49.83, which is right at its fair value.  AHGP has an equity summary score of 9.0 of 10
indicating analysts are very bullish on this stock.  AHGP has a current dividend yield of 5.1% with a dividend growth rate of 10%.  Looking forward 10 years, AHGP will have a yield on cost of 13.3%.

Reflecting record financial results for the year ended December 31, 2011, AHGP reported record net income for 2011 of $214.1 million, or $3.58 per basic and diluted limited partner unit, an increase of 22.8% compared to net income for the year ended December 31, 2010 of $174.3 million, or $2.91 per basic and diluted limited partner unit.  AHPG announced a dividend increase of 4.5% over the third quarter 2011 distribution of $0.61 per unit (an annualized rate
of $2.44 per unit).  AHGP enjoyed continued success in the 2011 as its distribution increased 20.9% over the prior year quarter.  We currently expect AHGP quarterly unitholder distributions in 2012 to grow at a pace similar to 2011.  AHGP is a BUY for income investors based on its growing dividend.

Dividend Stocks with Bond-like Yields

While some wonder if dividend investing is a fad, the strategy probably has staying power. Bonds yield little, and short-term rates are near zero, leaving individuals with few places to find yield. Demographics favor income investing; millions of baby boomers retire each year, and they want income to supplement Social Security and minimize the drawdown of retirement assets.

Opportunities are limited in the bond market, with Treasuries topping out at 3% and high-quality 30-year municipals at only 3.5% after a sharp rally in recent months. These yields are near the lows of the past 50 years.  Companies with high and sustainable dividends are often valued more like bonds than stocks, partly because 4% and 5% dividend yields often are higher than the rates on many corporate bonds.

A 4% dividend seems to resonate with investors who are willing to pay premium prices for companies with high yields. Some of the strongest S&P 500 industry groups last year — utilities, consumer staples and drugs — had some of the index’s highest yields.  During 2011, high-dividend payers were the top-performing group in the S&P 500, with the top 50 yielders at the start of 2011 — all with 4%-plus yields — returning more than 8% (not including dividends), compared with a flat showing for the entire index, according to Birinyi Associates.

The companies on the list below, including Merck (MRK), Pfizer (PFE), Waste Management (WM) and American Electric Power (AEP), have sustainable dividends and reasonable price/earnings ratios.

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The Best Dividend Stocks for 2012 – Industrial Sector

S&P recommends marketweighting the S&P 500 Industrials sector. Year to date through November 18, the S&P Industrials Index, which represented 10.6% of the S&P 500 Index, was down 6.3%, compared to a 3.3% decline for the S&P 500. In 2010, this sector index advanced 23.9%, versus a 12.8% increase for the 500. There are 18 sub-industry indices in this sector, with Aerospace & Defense being the largest at 24.9% of the sector’s market value.

S&P analysts have a positive fundamental outlook on the Industrials sector due to expected sales benefits from rising emerging market exposure, although Europe’s debt crisis has increased uncertainty, in our view. In addition, operating leverage is rising with revenues thanks to aggressive cost-cutting initiatives put in place by most companies during the extreme business downturn of 2008 and 2009. According to Capital IQ, from a valuation standpoint, the sector trades at 11.8X consensus estimated 2012 EPS, above the market’s 11.3X, due to above-average EPS visibility, in our view. Its P/E to projected five-year EPS growth rate of 0.9X is lower than the broader market’s 1.1X. The sector’s marketweighted S&P STARS average of 3.7 (out of 5.0) is slightly below the 3.8 average for the S&P 500.

The S&P Industrials Index have broken out from a fairly large, bullish base, turning the intermediate-term trend to bullish, in our view. In addition, prices have retaken a bearish trend-line off the highs since July, confirming to us the change in trend. The sector has also jumped back above its 17-week exponential moving average for the first time since July. The next area of overhead supply sits up near the 300 level, which was the major breakdown region. The rising 17-week exponential remains below the 43-week exponential, but the gap between the two is narrowing, a potentially bullish sign. Relative strength versus the S&P 500 has reversed to the upside, another positive sign. We have raised our technical opinion on Industrials to neutral with a bullish bias, from neutral.

We recommend marketweighting this cyclical sector due to increased risks we see to the global economic recovery, which we believe are offset by an improving technical outlook.

As the world’s largest defense contractor, Lockheed Martin (LMT) has amassed an enviable product portfolio.  Lockheed turns 8% of revenue into operating cash flow, which it uses to fund dividends and stock repurchases. Still, budgetary pressures that require the Department of Defense (DoD) to reduce spending by $350 billion over 10 years could be expanded to more than $950 billion should Congress be unable to come to a consensus on the upcoming debt reduction discussions.  However, LMT is on the technology side of DOD so they have not been hurt by budget cuts.  Aeronautics houses key fighter aircraft programs such as the fourth generation F-16 and the fifth generation F-22 and F-35.  The difference between fourth and fifth generation aircraft is related to stealth, computer systems, and the ability to process and integrate data to rapidly make informed decisions.  LMT has a dividend yield of 4.9%.

We believe that Eaton’s expansion into developing markets will pay nice dividends, even while developed economies in the U.S. and Europe face challenges. Over the long run, we think the firm’s advanced technologies and high switching costs should lead to solid economic profit generation.  Eaton is a diversified manufacturer of electrical components and systems across a broad number of end markets, but is importantly focused on the common theme of providing power solutions. Thus the firm has been successful at expanding its business well beyond its central focus of supplying to car and truck manufacturers, but hasn’t drifted too far outside of its core competencies.  Eaton also has a long history of dividend growth, based on a target of growing EPS by 15% per year and dividends in a like amount.  The dividend was maintained throughout the recession, and may grow once again as earnings recover.

The list of industrial stocks with bullish equity summary scores are shown in the table below: best dividend stocks of 2012 for industrials.

Best Dividend Stocks for 2012

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