The Most Important Factor in Selecting Dividend Growth Stocks

As I wrote in a recent post, with a lack of yield in most stocks today (due to the run up in stock prices), investment newsletters and other services are recommending dividend growth stocks in droves as potential yield is all they can hang their hats on with yield being tough to come by. I hope to expand upon the ideas in that post and further clarify the methods I use to find dividend stocks.

Yield and a history of dividend increases are not enough to invest in a stock. If we're placing a value on future dividends, we must be relatively certain that the company's future earnings will grow and be able to support growing dividends down the road.

There are a number of factors that contribute to whether future earnings will be sufficient for future dividend increases such as management, growth strategy, product innovation and so forth. What I believe is even more important is whether or not the macro-economic environment lines up in favor with a company's business over a multi-year and multi-decade time horizon.

While putting together an educated guess on whether or not the global economic picture will be favorable or unfavorable, produce headwinds or tailwinds, for a company, is difficult, it is still a worthwhile exercise done in conjunction with selecting core dividend growth stocks for portfolios.

Let's look at a few "categories" of companies for the sake of examples of such an exercise.

International Growth Companies

It's hard not to be an investor and hear constantly about "emerging markets" with regards to fueling growth for companies. Indeed if major markets like China, Brazil and India are not a part of internetional straetgy for any multinational, it would be a major red flag.

The questions to ask with regards to international growth might be as follows:

Do international markets represent real opportunity for the company? Is it early or late in the phase of penetration in such a market?

Is the product or service relevant in the international market(s)?

What is the management's approach to growing revenues in new and emerging markets?

I am on the record with stating that one of my favorite and what I believe is a very underrated international growth company is Wal-Mart Stores, Inc. (WMT). Not only is there great opportunity in retail in major markets like Brazil, India and China, I am a big fan of Walmart's strategy to leverage local brands (versus building Walmart Supercenters in every market). Walmart's dividend growth history is excellent and I strongly believe international growth will help fuel continued increases for years to come. You can read more on why I like Walmart here.

Side note: Walmart just announced a new $15 billion buyback - management likely sees their shares as undervalued as I do.

Technology & Communications Companies

One of the hardest things to do as an investor is buy a technology company because of a dividend. Technology changes so rapidly that it's near impossible to say whether or not a company's product will be relevant and profitable in ten to twenty years.

Let's first look at AT&T (T) and for that matter the competitors such as Verizon (VZ). As I discussed in a recent piece on innovation in the voice and data space, it's very hard to make any long-term bets on cell carriers. Who knows over which medium we will communicate in five years let alone ten or twenty years? While these companies have high yields, I believe the macro picture just doesn't line up with them.

Turning to Microsoft (MSFT) one of the more hated technology companies, I believe their future is much more positive than most would say. Their stranglehold on enterprise computers and software will still be an effective barrier against competition and provide a launching point for further innovation and products even as more people turn to mobile devices versus desktop computers. I'm excited about a future Microsoft tablet and believe they can also do well with future smartphones.

As consumers and businesses adopt more mobile devices and integrate it into their lives and workplaces, I believe Microsoft still has a strong enough footprint and market share to continue to grow earnings. Their balance sheet can be used to acquire newer technologies (recently Skype).

The macro environment definitely is a tailwind for companies that can earn money on the move towards mobile devices and further computing upgrades for busineses. While Apple (AAPL) fans and Microsoft haters don't like to hear it, Microsoft will absolutely benefit from this environment and continue to rack in profits for many years to come. Microsoft is a great future dividend growth company and is trading for a very attractive entry point currently.

Companies Buck The Macro Picture?

Cigarette companies might be sort of the odd-ball in this scenario. In developed countries like Europe and the U.S., cigarette volumes have been declining for some time. This is due to the health risks, taxes and so forth. Meanwhile companies like Altria (MO), parent of Philip Morris USA, and Philip Morris International (PM) continues to increase profits and as such, dividends to shareholders.

These companies have shown remarkable ability to continually increase prices and offset declining volumes to keep profits growing. This is definitely a unique characteristic of cigarettes most likely due to the addictive nature of the product.

With that said, Philip Morris Int'l does have growth potential in emerging markets and is my preferred play here over Altria.

Cigarette companies represent a unique type of business that has been able to increase profits over long periods of time despite a tough economic environment due to the unique characteristics of the product these companies sell.

Conclusion

When selecting core positions for a dividend growth portfolio, I think the most important factor is how the macro economic picture on a global basis lines up with the stock. It can be the difference in serious levels of return rates over many years.

Disclosure: I am long WMT, MSFT.