Each year, Standard and Poor’s publishes its dividend aristocrats index of dividend paying stocks. To many income investors, this list is considered the Holy Grail of income stocks. It is comprised of some of the world’s most well managed and profitable blue chip companies that can make for great investment opportunities.
The Dividend Aristocrats Index
Members of the dividend aristocrats are not the highest yielding stocks available. You won’t find any double digit yields amongst its members. In fact, most companies in this index have current yields below 4% and are usually between 2.0% – 2.5%.
Instead of finding high yields, investors get a great list of stocks that offer consistent dividend increases. While the aristocrats may not be the most glamorous investment options, they are usually dependable and stable. The index relies more on historical dividend trends of stocks as opposed to chasing the highest yields.
So how does a stock become a member of this prestigious index?
How to Become an Aristocrat
The criterion for becoming an aristocrat is quite simple. First, a stock must be a large cap, blue chip company and a member of the S&P 500. Second, the company must have raised their dividends annually for at least 25 consecutive years.
Those two criteria are used each December to re-balance the index for the upcoming year. If an existing member cuts their dividend over the course of the next 12 months, they are dropped from the index the following December. Even if a company on the list decides to freeze their dividend for a year, they are removed from the index. This criterion allows for only the elite dividend payers to be included.
Just as some stocks are removed from the index each year, any member of the S&P 500 that hits the 25 year threshold of consistently raising dividends is added each December. This annual review ensures that only the most consistent of dividend stocks is included in the index.
Note: The list of dividend aristocrats was recently re-balanced for 2011 and includes over 40 investment options. For more details about the index, check out the Standard and Poor’s site highlighting the dividend aristocrats members for the upcoming year.
Investing in the Aristocrats
While this index of top dividend stocks highlights consistent performance, it should not signal an immediate buy for investors for several reasons. First, the index is only reviewed annually each December. A company that cuts its dividend during the year is actually not removed until the review period, which can be a little misleading. During the financial crisis a few years back, several financial companies (i.e. Bank of America) were found on the index but were forced to make dividend cuts to stay in business. Investors should always check if a company has frozen or cut its dividend during the past 12 months.
Investors should also do their own due diligence on a stock found in this index prior to making a purchase. There are other factors involved than just consistent dividend increases. For example, a company may have a very high payout ratio that increases each year. An increase in this ratio means that a company is paying more and more of their earnings in the form of dividends instead of investing it back into growing the organization. This could actually be a red flag of a future dividend cut for investors as the company may not be able to maintain dividend increases much longer.
Another reason why not every member of the dividend aristocrats is a good investment is the current yield. There are several stocks on the index that actually have a yield under 2.0%. While they may have a good history of providing annual dividend increases, the yield may be just too low. As the yield drops below this threshold, other investments like certificates of deposit become more attractive. Why risk your money in the stock market when you can get a guaranteed return on a CD?
The S&P 500 Dividend Aristocrats index is made up of some of the best income producing stocks available to investors. While the yields may seem low compared to other high yielding stocks, the companies found on this list tend to be stable and dependable. Most successful income investors use this index as a tool to help screen potential investments.
As with any other investment, an income investor should not treat this list as a signal to buy each member. Instead, the list should serve as an investment tool that is used in combination with other analysis and criteria. The dividend aristocrats are an excellent place to start your search for great companies that can help you build a steady income stream. Just be sure to use it with caution and always do your own due diligence before making any investment decision.
Do you use the list of dividend aristocrats as an investment tool for finding high quality income stocks? What other criterion do you use to screen your dividend stocks?