3 Attractive High Quality Dividend Stocks To Buy Now

Most savvy investors are generating 4-5% by parking their excess cash in money market funds given elevated Fed Funds rate.  But what happens when the Fed decides to lower rates and the interest payments decline?  In this blog post, we will discuss our approach to identifying 3 quality dividend stocks for steady portfolio income beyond traditional dividend ETFs, like VYM or SCHD.

Disclaimer: Before we dive into the details, please note that identifying individual high paying dividend stocks implies greater investment risk.  Therefore, the analysis and list of stocks presented below are not financial recommendations. We are not financial advisors and suggest you do your own research as everyone’s investment objectives and risk profiles are unique.

Why own individual dividend positions?

As long-term value investors, we invest in low-cost passive S&P 500 ETFs FIRST as part of an overall diversified portfolio strategy, before individual positions.  We believe every portfolio should have an S&P 500 index fund and for income, a combination of high-yield dividend ETF and fixed income bonds.  However, even the most popular high-yield dividend ETFs (e.g., VYM and SCHD) pay annual dividend yields below 4% (2.68% and 3.25% respectively).  This is why investors typically look to boost their income by including individual positions of high-quality stocks that not only pay dividends but consistently grow their dividends over time.   

It’s important to remember that historical performance does not guarantee future performance and like all investments, there will be risk. Our goal for the analysis is to identify resilient, high quality dividend paying stocks that provide an attractive risk-reward opportunity, potentially different from other approaches.

What is our dividend screening approach?

For our starting point, we analyzed only S&P 500 companies that paid an annual dividend yield above 3% using FinViz’s stock screener.  Next, we applied the following criteria to prioritize the initial list of ~134 companies:

• High Dividend Yield: Pay out of at least 3% since this is the average dividend yield of SCHD and VYM.  Individual positions should provide higher dividend yields than benchmark ETFs.
• Dividend Growth: The dividend growth rate is the annualized growth rate over the last 3 years. We prioritized companies with annualized dividend growth rates of at least 2.9%, which is the average of VYM and SCHD.
• History of Dividend Payouts: We prioritized companies that have consistently paid dividends for at least the last 25 years.
• Payout Ratio: This metric measures the sustainability of a company’s dividend because it measures the dividends paid relative to the total net income of its after-tax earnings.  On average, stocks with a safe dividend payout ratio has been around 41%.  
• Beta: Beta is a measure of the volatility of a stock compared to the S&P 500.  The beta is indexed against the stock market benchmark and therefore, a beta value equal to 1 means that it moves with the market.  A stock’s beta value of less than 0.5 suggests that it is 50% less volatile than the market. We prioritized companies with a beta value of less than or equal to 0.5.
• Relative Price Return: We prioritized companies that demonstrated an average 5-year price return greater than 38.8%, which is the average return of VYM and SCHD.

After compiling this analysis, we calculated total aggregate scores for each company based on both equal and prioritized weighting of the variables above on a scale of 1-7 with the prioritized ranking as follows:

1. Beta (least important)
2. Overvalued
3. Price Return
4. Dividend Yield
5. Payout Ratio
6. Years of Dividend Payout
7. Dividend Growth (most important)

We prioritized dividend growth, years of dividend payout and payout ratio as relatively more important to reflect companies with more sustainable dividend profiles.  Once we calculated the aggregate scores for each company, we identified companies in the top quartile.  Finally, we evaluated LT debt/equity ratio, free cash flow-to-gross revenue and EPS next 5 years metrics. These metrics will help us evaluate each company’s debt, whether they can pay the dividend directly via free cash flow, and their projected earnings over the next 5 years.

It’s important to go through this rigorous exercise in order to identify high quality and relatively safe income paying companies. Most beginners only look at the dividend yield and think the higher the yield, the better.  However, this is a MISTAKE because companies that provide a high dividend are often unsustainable. This normally occurs because of the following:

1. The company needs to raise capital from public investors because their financial operations are unstable.  They tempt investors in providing them with a high dividend yield, however, because the underlying financial operations may be shaky, this could ultimately lead to erosion of your total return. 
2. The company is looking to reward their investors because of better-than-expected earnings performance or they experienced a windfall. Either way, this dividend payout may likely be unsustainable moving forward.

For beginners, some examples of high paying dividend companies that may be risky include: AT&T (ATT) and Verizon (VZ). When comparing these companies, both AT&T and Verizon appear to have attractive dividends of 6.29% and 7.02% respectively.  However, as seen in the chart below, both stocks are down 23-25% over the last 5 years!  This is a classic example of chasing yield only to give it back up in the price return.

Other companies that are risky especially in a high interest rate environment are mortgage REITS or companies with businesses that hold a lot of debt on their P&L.  The key point is not to chase dividend yields, but to evaluate the overall financial health of these companies.

Which dividend stocks are attractive?

We are prioritizing: Public Storage (PSA), AbbVie (ABBV), and Exxon Mobil (XOM).  All three companies rated favorably on our key metrics, have strong free cash flow-to-revenue, low betas and payout ratios.  

Below, we discuss our investment thesis and rationale on why we believe these companies warrant greater consideration:

Public Storage (PSA)

Public Storage (PSA) is a real estate investment trust (REIT) that specializes in the ownership, operation, and development of self-storage facilities in the United States and Europe.  They are the market leader among self-storage competitors (e.g., Extra Space Storage, CubeSmart, Neighbor, Life Storage) based on both revenue and number of facilities.  Beyond leasing self-storage space to customers, they also sell merchandise to tenants in the form of locks, boxes, packing materials and reinsurance. 

Here is our investment thesis for PSA:

1. Strong and Stable Cash Flow: Public Storage generates stable and predictable cash flows from its self-storage properties, which can provide consistent dividend payments to investors. The company has a long history of increasing its dividend, having raised it every year since 1988. This steady income stream can be attractive to investors looking for consistent returns.
2. Resilience to Economic Downturns: Self-storage is a non-cyclical business, which means it is less sensitive to economic downturns. In fact, demand for self-storage often increases during tough economic times when people downsize their living arrangements or need to store possessions due to job loss or other financial challenges.  
3. Growth Potential: Public Storage has a strong track record of acquiring and developing new self-storage facilities, which has allowed it to expand its footprint over time. The company has a significant pipeline of development projects and is also expanding into new geographies, such as Europe.  The self-storage market continues to remain highly fragmented which presents continued growth opportunities by acquiring properties owned and operated by individual or small businesses.  
4. Strong Management: Public Storage is led by a seasoned management team with deep industry expertise. The company has a strong balance sheet and a disciplined approach to capital allocation, which has helped it weather economic storms and position itself for long-term success.
5. “Difficult to Replicate” Competitive Advantages: Their strong competitive advantages include the quality of their facilities, their internal data and operating expertise and excellent customer experience.  Additionally, they have invested heavily in digitally transforming the entire end-to-end business operations from the leasing process, to “hands free” digital property access for parking gates, doors, elevators via the Public Storage App, customer account management and security.  60% of their move-ins are done via digital leases compared to only 20-35% of other self-storage REIT peers.

In looking at its business operations, their performance has been impressive.  Given the breadth of its locations, they have consistently reported higher than average occupancy rates vs. their peers (94.9% vs. 92% in 2022) while still acquiring new properties and simultaneously, improving both their occupancy rates and net operating income.  Finally, they have lower long-term debt to equity ratios than competitors such as Extra Space Storage (PSA: 1.2 vs. EXC: 2.25), suggesting relatively lower interest rate risk.

Their business is largely recession proof with predictable revenues that grow every year due to rent increases, operating efficiencies and new sites.  The rise of consumerism, the 4 D’s (death, disaster, divorce, and displacement) and urbanization will continue to be important catalysts for driving future demand.  According to Sparefoot’s latest 2023 report, ~11.1% of households currently rent a self-storage facility while Storage Café’s survey of 18,000 people suggest that 1 in 5 Americans currently rent self-storage!  They also suggested that an additional 15% plan to rent self-storage in the future.

However, please keep in mind that PSA is a REIT and therefore, the dividend payment is taxed as ordinary income.  Additionally, other risks include increasing competition from other lower cost self storage providers (e.g., Neighbor) as well as slow-down in housing sales may represent more renters staying put and thus, impacting future rental growth.

Overall, Public Storage may be an attractive investment for investors seeking a stable and growing dividend stream, a resilient business model, and long-term growth potential.  

AbbVie (ABBV)

AbbVie is a global pharmaceutical company focused on developing and commercializing medicines in specialty therapeutic areas, most known for Humira which is the self-injectable auto-immune disorder drug and the best-selling drug in history.   They have multiple innovative billion-dollar products in high profit disease areas (e.g., oncology, immunology and neuroscience).  AbbVie has long been a dividend income investor favorite, boasting not only a 3.7% dividend yield, but also 51 years of dividend payouts.

Here is our investment thesis for why we are prioritizing AbbVie on our watch list:

1. Diverse Portfolio: A few years ago, the greatest risk to AbbVie’s business was Humira’s patent expiration since ~50-60% of AbbVie’s total sales were concentrated in Humira.  However, they have significantly invested in R&D and M&A and have now reduced Humira revenue reliance to ~40%.  New immunology products in Skyrizi and Rinvoq, growth of its oncology and neuroscience businesses and acquisition of Allergan’s neuroscience and cosmetic dermatology portfolio should mitigate any sales drop-off in sales after Humira’s patent expiration.
2. Innovative Products: In evaluating AbbVie’s portfolio, their focus on innovative products, especially in immunology & oncology rather than “me too” products allow them not only greater pricing power, but also additional long-term revenue opportunities to pursue in disease areas of high unmet need.  Their focus on clinically innovative products also allows them to maintain greater operating margins than other pharmaceutical companies (e.g., less rebates and discounts to customers) and return relatively more shareholder value over time.
3. Strong Market Access:  Patient access to drugs is becoming more complex and making it extremely vital for achieving sales forecasts.  Fortunately, AbbVie has secured highly favorable access for its anchor portfolio products with insurance companies.  Key products such as Skyrizi, Rinvoq and Imbruvica have favorable access without restrictions, making it easier for doctors to prescribe AbbVie’s products. This represents a significant competitive advantage so that patients and doctors have a positive onboarding experience.  Additionally, AbbVie has invested in generous financial assistance programs, reducing the affordability burden for patients.
4. Best-in-Class Commercial Model:  AbbVie’s maximizes the value of its medicines across patient access, pricing & contracting, supply chain & distribution, account management and customer support.  Customers and vendors consistently rank AbbVie superior to other pharmaceutical companies. Additionally, AbbVie insources their own pharmacy and customer support CRM (e.g., Pharmacy Solutions) which further differentiates them via quality customer interactions, targeted interventions, and rapid turnaround times.
5. Strong Financial Performance: The company has consistently generated strong revenue growth and earnings, with a solid balance sheet and cash flow position. AbbVie also has a history of returning value to shareholders through dividends and share buybacks.

Investors should monitor AbbVie’s Humira, Skyrizi and Rinvoq sales closely.  Amgen’s Humira biosimilar launched in 2023 Q1 and according to AbbVie’s 2023 Q1 earnings, they missed on their immunology sales forecasts by 9%. This may be a signal that there may be further weakness ahead. We will wait until later this year to consider adding it to our portfolio once their is more predictability of the full sales impact of the biosimilars and market uptake of Skyrizi and Rinvoq in new disease areas.

In summary, AbbVie is a pharmaceutical company with a strong financial position, a diverse portfolio of products, a robust pipeline of innovative drugs, a competitive position in key therapeutic areas, and a disciplined approach to capital allocation. These factors make AbbVie a potential investment opportunity for investors seeking exposure to the pharmaceutical sector.

Exxon Mobil (XOM)

Exxon Mobil is a multinational oil and gas business with strong competitive advantages due to its huge production and refining capacity as well as its broad marketing network. The business is active all over the world, with a significant presence in the US, Canada, and Europe. The market value of Exxon Mobil is approximately $469 billion, which is 45% higher than its closest competitor, Chevron (CVX).  The company looks attractive due to its low payout ratio, low beta, favorable free cash flow-to-revenue metrics, market dominance in the integrated oil & gas industry, and positive free cash flow-to-revenue metrics.

Here is our investment thesis for why we are prioritizing XOM in our watch list:

1. Competitive Advantages: Exxon Mobil’s competitive advantages in exploration, production, refining, and marketing enable it to operate efficiently and profitably, even in challenging economic cycles. The company’s extensive refining and marketing network also helps it to mitigate the impact of volatile oil prices on its financials.
2. Energy Demand Trends: While the demand for oil and gas is expected to continue to grow over the long term, there are a number of trends that could impact demand in the medium to long term. However, Exxon Mobil is well-positioned to capitalize on these trends through its investments in lower-carbon technologies, such as carbon capture and storage, and its partnerships with renewable energy companies.
3. Strong Financial Position: Exxon Mobil has historically been a profitable company, with a strong balance sheet and significant cash reserves. Despite the pandemic and the decline in oil prices, the company has maintained its financial strength and has taken steps to reduce its costs and improve its cash flow.
4. Dividend: Exxon Mobil has a history of paying dividends to its shareholders, and the current yield of 5% is attractive to income-seeking investors. The company’s strong financial position and its extensive refining and marketing network also suggest that the dividend is likely to remain stable in the long term.
5. Valuation: Exxon Mobil’s current valuation is lower than its historical average, which may present an opportunity for investors. While the company faces a number of challenges, such as the changing energy landscape and regulatory pressures, its competitive advantages, strong financial position, and dividend yield may make it an attractive investment during a challenging economic cycle.

Macroeconomic conditions, geopolitical risk and supply and demand of oil supply and pricing may impact Exxon Mobil’s short-term earning potential.

Overall, Exxon Mobil’s competitive advantages in exploration, production, refining, and marketing, along with its investments in lower-carbon technologies, make it well-positioned to navigate the changing energy landscape. Its strong financial position and dividend yield also make it an attractive investment during a challenging economic cycle.

We hope that you found our analysis helpful when evaluating dividend paying stocks for your portfolio. Please note that no one can predict the future and it’s important to tailor your own expectations based on your investing time horizon. As a reminder, please do your own research and none of the information above is meant to be investment recommendations. Thanks and we hope this has been insightful!

If you are interested in the free investment tools that we use to inform our research and analysis, please check out the following:

• Portfolio back-testing: Portfolio Visualizer
• Stock screener research: FinViz.com
• Company fundamentals analysis: Stratosphere.io

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