Blue chip dividend stocks can be some of the most appealing investment opportunities for income and capital appreciation. If you have ever wondered what blue chip dividend stocks are, why they are attractive, where you can find them, and what the best ones are, you have come to the right place.
What are Blue Chip Dividend Stocks?
The term “blue chip” is said to have originated in the 1920s by Dow Jones reporter Oliver Gingold. The story goes that Gingold was at a brokerage firm when he observed several trades that took place at high prices (e.g. $200 per share) and said to nearby securities analyst Lucien Hooper that he planned to write about these “blue chip stocks” when he returned to his office. The term initially referenced stocks with high share prices but is more commonly associated with high quality today.
The “blue chip” term used by Gingold actually comes from the game of poker. The simplest set of poker chips comes in three colors – red, white and blue. As you might have guessed, the blue chips are the highest in value. While not all blue chip stocks pay a dividend, most do because they are generally mature businesses and have significant retained earnings and cash flow to distribute.
Blue chip dividend stocks are typically large in size (e.g. market caps exceeding $10 billion), have tremendous financial strength, maintain leading roles in the economy, generate dependable earnings, and are thought to be much safer and more durable than the average stock. Most of these companies have paid and increased their dividends for many years as well, a signal of financial strength and stability.
Blue chip dividend stocks are popular in part because of the contribution dividends have had to the market’s overall return. According to S&P, since 1926, dividends have contributed nearly a third of total equity return while capital gains have contributed two-thirds. Dividends also suggest a company is profitable, stable, and confident in its long-term outlook.
Blue chip dividend stocks have generally proven to be some of the most durable companies around and appeal especially to conservative investors interested in holding stocks for many decades. While blue chip stocks aren’t guaranteed to be great investments, it is a good starting place for identifying high quality businesses.
How to Find Blue Chip Dividend Stocks
Many investors simplify their search for blue chip dividend stocks by targeting companies that have increased their dividend for at least 10 consecutive years. Famous value investor Ben Graham noted in his book “The Intelligent Investor” that conservative investors should seek out companies that have been paying out steady dividends for at least 20 years.
Consistent dividend increases are often a sign of dependable profits and management’s confidence in the future of the business. Not surprisingly, the pool of companies that has achieved such a feat is rather limited. According to our database containing thousands of dividend-paying stocks, just over 150 have increased their dividend for at least 20 consecutive years. You can see that list by clicking here.
Other investors prefer to search for the best blue chip dividend stocks in the list of dividend aristocrats, which consists of members of the S&P 500 that have raised their dividend for at least 25 consecutive years. On an annualized basis, the S&P 500 Dividend Aristocrats Index has outperformed the S&P 500 by 2.83% per year over the last 10 years and beat the market by 15% in 2008 (see below). It’s no wonder why income investors are attracted to these companies.
While these lists are great to places to start your hunt for blue chip dividend stocks, it is important to remember that analyzing dividend growth streaks is akin to looking in the rearview mirror. Many blue chip dividend stocks have overcome numerous business challenges in the past, but that does not guarantee their future safety or survival.
Shocks such as the global recession of 2008 highlight the occasional vulnerability of even the “best” perceived companies (e.g. General Electric). The effects of capitalism and the “creative destruction” it induces result in business risk as well.
Comparing the list of Fortune 500 companies in 1955 to the most recent Fortune 500 list, we can see that only 61 companies are on both lists. Said another way, about 88% of the companies from 1955 either went bankrupt, merged, or fell from the top 500 companies as their businesses shrank.
According to a study of the S&P 500 Index conducted by consulting firm Innosight, the rapid pace of technological change, increased globalization of economies, and intensified pressure from startups is shortening the average life of companies even more today. The report noted that the 61-year tenure for the average firm in 1958 shrank to 25 years in 1980 and 18 years in 2011. In other words, using the churn rate observed in 2011, 75% of the S&P 500 would be replaced by 2030!
A Wall Street Journal article about blue chip dividend stocks in 2014 highlighted some of the challenges recently faced by these massive businesses. It notes that many of these companies were so successful that the large revenue base they built up made them too big to switch strategies quickly when market conditions changed. Some examples it lists of blue chip companies struggling for profitable growth are Walmart, IBM, AT&T, and Coca-Cola.
While they are all still cash cows, blue chip dividend stocks must reinvest and shift their sales mix to rejuvenate their prospects for long-term earnings growth. Otherwise, over the next several decades, they risk becoming just another statistic.
Capitalism makes our lives better every day in the form of new products, increased conveniences, lower prices, and more. However, it can create headaches with our investments if we are not careful with our diligence process.
Blue Chip Dividend Stocks – Investment Checklist
Reviewing the following checklist can help you avoid blue chip dividend stocks that carry higher amounts of business risk. While it’s far from exhaustive, it hits on many critical issues that can be quickly researched using our Stock Analyzer tool.
Item 1: Has the company’s rise to success been driven more by luck or skill?
Some companies found themselves in the right place at the right time. Think about the housing market boom or the commodities market fueled by China’s debt-fueled infrastructure binge. Sometimes the best-performing, most consistent dividend growth stocks are tied to a long-tailed cycle that is about to end – either from demand reaching a peak or new supply entering the market (e.g. changing consumer preferences, new competition, technological change, etc.). What macro factors is the stock sensitive to? Have those factors been benefiting from unsustainable sources of demand or unreasonably constrained supply? Most things in life are cyclical – understand what cycles might be driving your stocks and where they are in their lifecycle. On the flip side, investing in long-tailed themes that are closer to their beginning than their end can be a great investment strategy.
Item 2: Do recent business trends raise any red flags about how the world is changing?
As they say, the “proof is in the pudding.” A company’s financial results offer a glimpse into how the changing world is impacting its ability to survive and grow. If sales have started declining or profitability has stalled, you need to determine if the factors causing those results are temporary or the start of a long-tailed headwind. If it’s the latter, remember how difficult it is and how long it takes for large blue chip dividend stocks to shift their mix into profitable areas of growth. There might be an even better entry point six months down the road.
Item 3: Does the company generate reliable free cash flow?
The best blue chip dividend stocks will generate free cash flow year in, year out. Cash is money in the bank and allows the company to create value in many different ways – reinvestment into new products (increases durability), dividend increases, debt reductions, share repurchases, and acquisitions. Without free cash flow, companies have fewer resources at their disposable to continuously reinvent themselves and can also be more dependent on access to credit markets. Both of these factors can significantly shorten a company’s lifespan.
Item 4: Is the company’s balance sheet healthy enough to survive the next storm?
Surprises happen. That is one reason why investing is so hard. If a negative shock occurs and a business is saddled with heavy amounts of debt, limited cash reserves, and declining cash flow, the value of your investment can plummet. The dividend could also come under pressure, depending on the severity of the struggle.
Item 5: How large is the market?
The bigger the market, the more opportunity blue chip dividend stocks have to continue growing. Think about how fast end markets are growing (e.g. about in line with GDP), what secular themes support long-term growth (e.g. rising consumer wealth in emerging markets), the reasonable paths a company has to expand into adjacent markets (e.g. Coca-Cola using its distribution network to launch healthier beverages), and the ease at which new competition could enter or change the market’s dynamics (e.g. imports from new China, technology advancements, etc.).
Item 6: How has the payout ratio trended over time?
A company can grow its dividend using different means – free cash flow growth, raising debt, or issuing shares of stock. The only sustainable form of dividend growth is free cash flow growth. The payout ratio measures how much cash flow or earnings a company’s dividend is consuming. We prefer to see dividend growth in excess of the rate of inflation (3%+ per year) and stable payout ratios, meaning the dividend is growing in line with cash flow growth. For cyclical companies, we like payout ratios below 50% (and healthy balance sheets). For more stable businesses, payout ratios less than 70% are desirable to us. Lower payout ratios provide more cushion for the dividend and opportunity for growth, even if earnings growth temporarily slows.
The Best Blue Chip Dividend Stocks
Applying our checklist from above and screening through the various lists of dividend growth streaks, we created the following list of blue chip dividend stocks that look interesting for further research. These businesses generate consistent free cash flow, maintain conservative balance sheets, have exhibited stable payout ratios, operate in large markets, and appear to play in industries with slower rates of change.
|Ticker||Company Name||Sector||Industry||Mkt Cap ($M)||Dividend Yield||Ex-Dividend Date||pay_date||Dividend Growth Streak||EPS Payout||FCF Payout||1yr Dividend Growth||three_year_dividend_growth||5yr Dividend CAGR||10yr Dividend CAGR||ROIC||one_year_sales_growth||5yr Sales CAGR||one_year_EPS_growth||5yr EPS CAGR||1yr Total Return|
|ABT||Abbott Laboratories||Medical||Pharma||103,931||1.9||04/12/2018||02/15/2018||Less than 5 years||83||45||3||6||-8||-2||2.6||29.0||-1||255||-21||42|
|ADM||Archer-Daniels-Midland Company||Consumer Staples||Agricultural Operations||23,807||3.2||02/16/2018||03/13/2018||20 or more years||60||50||7||10||13||10||5.4||-6.0||-5||-41||-7||-2|
|ADP||Automatic Data Processing, Inc.||Business Services||Outsourcing||52,151||2.1||03/08/2018||04/01/2018||20 or more years||58||58||8||6||8||10||29.0||6.0||3||11||6||20|
|AFL||Aflac Incorporated||Finance||Insurance||35,214||2.3||02/20/2018||03/01/2018||20 or more years||25||11||5||5||5||8||10.3||-4.0||0||18||9||27|
|BDX||Becton, Dickinson and Company||Medical||Medical Products||58,664||1.4||03/08/2018||03/30/2018||20 or more years||63||48||11||10||10||12||5.4||-2.0||10||-142||-4||29|
|CAH||Cardinal Health, Inc.||Medical||Dental Supplies||21,812||2.7||03/29/2018||04/15/2018||20 or more years||53||30||12||13||15||17||8.1||2.0||4||-63||6||-12|
|CB||Chubb Corporation (The)||Finance||Property & Casualty Insurance||66,853||2.0||03/28/2018||01/19/2018||20 or more years||33||27||3||3||8||10||6.8||1.0||13||-105||14||13|
|CL||Colgate-Palmolive Company||Consumer Staples||Soap & Cleaning Preparations||61,535||2.3||01/22/2018||02/15/2018||20 or more years||61||56||3||4||5||9||39.6||3.0||-2||-13||2||10|
|CLX||Clorox Company (The)||Consumer Staples||Soap & Cleaning Preparations||16,749||3.0||04/24/2018||05/11/2018||20 or more years||60||59||4||4||6||10||36.4||4.0||2||7||5||8|
|CMI||Cummins Inc.||Auto, Tires, Trucks||Engines||28,136||2.6||02/22/2018||03/08/2018||10 to 20 years||42||42||5||14||19||26||16.7||26.0||-1||58||-3||23|
Blue chip dividend stocks can be great investments, especially for investors living off dividends in retirement. However, purchasing stocks simply because they are a dividend aristocrat or part of the Dow Jones is an unnecessarily risky activity. Data shows that the average lifespan of an S&P 500 company has dropped from 61 years in 1958 to less than 20 years more recently. Companies that were once dominant giants are more vulnerable to change than ever before. Run each of your ideas through our blue chip checklist and conduct additional research to give yourself the best chance of investing in dividend stocks that will not only survive the next storm but emerge with higher dividend payments and more cash flow coming in the door.