The truth is, no one knows if a company has what it takes to reward its investors with a lifetime of passive income. But there are criteria you can use to determine the sustainability of a dividend-paying company or exchange-traded fund (ETF).
One factor is a company’s history of paying and increasing its dividend. American States Water(NYSE: AWR) And Illinois tools work(NYSE: ITW) are both Dividend Kings – meaning they have paid and increased their dividends for at least 50 consecutive years – a track record that demonstrates their ability to grow profits and pass the growing profits on to shareholders through dividends.
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Meanwhile, the JPMorgan Nasdaq Equity Premium Income ETF(NASDAQ: JEPQ) is a unique ultra-high return investment that uses financial instruments to generate income, primarily from growth stocks.
Here’s what makes these two Dividend Kings and this ETF great buys right now.
Image source: Getty Images.
Scott Levine (American Water): Finding companies that have continued to raise their dividends for almost seventy years isn’t all that common, but that’s exactly what American States Water stands for. And for those wondering if the company will soon falter in its ability to continue the streak, it’s best to think twice, because there are plenty of reasons to believe that the water company’s stock is paying out will continue to increase for many years to come. For income investors looking to strengthen their passive income streams, Dividend King American States Water – along with its 2.2% term-yielding dividend – is a great opportunity.
A large part of the reason why American States Water is so successful in returning capital to shareholders through its dividend is that the company operates primarily in regulated markets. For example, in 2023, the company’s regulated activities represented 80% of its total turnover. While the company cannot arbitrarily increase rates for its water and wastewater services, it is assured of some return. This gives management a clear outlook on future cash flows, allowing it to plan capital expenditures such as infrastructure upgrades, acquisitions and dividends accordingly.
With the recently announced dividend increase, American States Water has increased its dividend for 70 years in a row. And these are not nominal increases either. Over the past five years, American States Water has increased its quarterly dividend to a compound annual growth rate of 8.8% – a period in which it has averaged a 57% payout ratio, partly illustrating how management’s understanding of cash flows can improve. help return capital to shareholders without jeopardizing the company’s financial well-being.
Since there is no drastic change in the company’s business model in the works, the company will likely continue to thrive – generating steady cash flows and increasing the dividend in the coming years.
Daniel Foelber (Illinois tools work): Illinois Tool Works, better known as ITW, hit an all-time high on Monday. And there are plenty of reasons to believe it’s still a good buy.
ITW actually consists of several companies under one umbrella. The industrial conglomerate operates seven segments: automotive, food equipment, test and measurement and electronics, welding, polymers and fluids, construction products and specialty products. And there are many, if not dozens, of brands in each segment.
Last quarter, no segment accounted for more than 21% of sales, and every segment had an operating margin of more than 23%, except automotive, which had a margin of 19.4%. ITW is a textbook example of the benefits of the industrial conglomerate model. In themselves, all segments of ITW have a certain cyclicality. However, under one company they can help smooth out volatility and diversify the broader business, while benefiting from synergies such as lower administrative costs.
ITW’s success with the industrial conglomerate model is impressive, as some notable players are moving away from that model. GE spun off into three different companies. And an activist investor recently proposed that Honeywell International spun off its aerospace segment from the rest of the company.
With a price-earnings ratio (P/E) of 23.9, ITW appears to be a good value at first glance. But the earnings are somewhat misleading, as ITW benefited from a divestiture gain of $1.26 in the last quarter. ITW expects full-year earnings per share of $11.63 to $11.73. If we exclude the one-time gain from the divestiture, the adjusted figure at the midpoint would be $10.42, giving ITW a price/earnings ratio of 26.5 based on the share price at the time of writing this article, of assuming expectations are met. For context, ITW’s average price-to-earnings ratio over the past three to 10 years has been 23.4 to 24.6.
ITW is a bit pricey, but it deserves a premium rating. ITW is one of the few major industrial companies with virtually no major problems in the past five years. Even during the height of the pandemic, sales declined at a manageable level and margins remained in the low 20% range.
ITW Revenue (TTM) data by YCharts
As you can see from the chart, ITW has continued to grow its operating margin and revenue. It has returned profits to shareholders through a combination of buybacks and a growing dividend. Over the past decade, ITW has reduced its share count by 22.9% through buybacks – an extremely impressive pace that few other industry giants can match.
In short, ITW checks all the boxes for a dividend stock you can buy for a lifetime of passive income. The valuation isn’t cheap and the yield is only 2.2%, but ITW offsets these drawbacks with its high-quality business and a versatile capital return program that includes buybacks and dividends.
Lee Samaha(JPMorgan Nasdaq Equity Premium Income ETF): One of the problems with investing in high-yield stocks is that it often results in an unintended sector or style bias that is reflected in your portfolio.
In layman’s terms, you might end up with a portfolio overloaded with stocks in a sector that was trading at high returns at the time, such as oil and gas exploration and production companies. Similarly, high-yield stocks often have certain characteristics, such as being low-growth, mature, cash-cow companies.
Both outcomes are fine for many investors, but this JPMorgan ETF could be the solution for investors who prefer a more flexible approach. The ETF invests 80% of its assets in shares. The prospectus claims “significant” investment is being made in it Nasdaq-100 shares, but management has the latitude to also invest in shares outside the Nasdaq-100 index.
The key point is that management actively manages the ETF to invest in growth stocks, and dividend yield is not a priority.
The ETF’s main revenue generator comes from its investments (up to 20% of the ETF’s assets) in equity-linked notes (ELN) that sell call options on the Nasdaq-100. As such, the ETF receives a premium when the index falls or does not rise above the option’s strike price.
The options strategy will lose money when the markets are on fire, but earn premiums when they are relatively calm or falling. As such, the upside of the ETF is limited (although it will still likely rise if tech stocks do well), but so is the downside. However, investors will receive a monthly distribution, exposure to growth stocks and a nice dividend at the same time.
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Daniel Foelber has no position in any of the stocks mentioned. Lee Samaha has no positions in the stocks mentioned. Scott Levine has no position in any of the stocks mentioned. The Motley Fool recommends GE Aerospace and Illinois Tool Works. The Motley Fool has a disclosure policy.
2 Outstanding Dividend King Stocks and 1 ETF to Buy for a Lifetime of Passive Income was originally published by The Motley Fool
