Don’t Ignore the Growth Potential of These 3 Dividend Stocks

Many dividend stocks have fallen out of favor over the past year as rising interest rates made certificates of deposit, bonds, and T-bills more attractive options for income investors. But those fixed-income investments will still underperform most blue chip dividend stocks over the long term for two reasons: Stocks generally appreciate in value, and their gains can be compounded over time through dividend reinvestment plans (DRIPs).

Therefore, investors should still own a few reliable dividend stocks even if interest rates remain high. I believe three stocks — Coca-Cola (KO), Johnson & Johnson (JNJ), and IBM (IBM) — fit that description.

1. Coca-Cola
Many dividend investors love Coca-Cola for three reasons: It runs an evergreen business; it’s a Dividend King, having raised its payout annually for 61 consecutive years, and it pays an attractive forward dividend yield of about 3.1%. It also generated an impressive total return of 435% over the past two decades.

Coca-Cola might initially seem like a risky investment because soda consumption is declining globally. However, the company prepared for that paradigm shift by expanding its beverage portfolio with more brands of bottled water, teas, juices, sports drinks, energy drinks, coffee, and even alcoholic beverages.

As for its namesake soda and other carbonated beverages, it’s keeping consumers interested with new flavors, sugar-free versions, and smaller serving sizes.

That’s why Coca-Cola still expects its organic revenue to rise about 7% to 8% this year, even as it faces inflation and intense currency headwinds, and for its earnings per share (EPS) to rise 4% to 5%. The company’s stock is still reasonably valued at 23 times forward earnings, and it remains one of the safest stocks to hold in both bear and bull markets. It won’t generate massive gains this year, but investors shouldn’t ignore the growth potential of this classic dividend stock.

2. Johnson & Johnson
Johnson & Johnson is another Dividend King, having hiked its payout for 60 straight years. It currently pays a forward yield around 3%. Like Coca-Cola, J&J is another blue chip stalwart that has easily resisted economic downturns over the past several decades. The company also generated an impressive total return of more than 360% over the past 20 years.

J&J’s diversified portfolio of pharmaceuticals, consumer healthcare products, and medical devices enables it to generate consistent growth by offsetting the weaknesses of its slower businesses with the growth of its stronger ones. Its consumer healthcare business struggled with slower growth and safety-related lawsuits in recent years, but it plans to spin off that troubled unit into a separate company this year.

J&J’s pharmaceutical business is also grappling with patent expirations for several of its blockbuster drugs, but it has been investing heavily in smaller drugmakers to offset those declines.

For now, analysts expect J&J’s revenue and earnings to grow 3% and 4%, respectively, this year. Those growth rates might seem slow, but the stock is also dirt cheap at 14 times forward earnings. That low valuation should limit its downside potential and convince more investors to buy J&J as a safe dividend play for this bear market.

3. IBM
IBM struggled for years as the sluggish growth of its legacy businesses continuously offset the faster growth of its cloud-oriented businesses. But that changed last November when it finally spun off its managed infrastructure services as Kyndryl. That long-overdue divestment enabled IBM to focus on expanding its higher-growth hybrid cloud and artificial intelligence (AI) businesses.

Instead of competing head to head against Amazon and Microsoft in the public cloud market, IBM is launching more hybrid cloud and AI tools, which process the data flowing between public and private clouds. Its 2019 acquisition of Red Hat, a developer of open-source software, also enables it to develop tools that are compatible with a wide range of cloud services.

This new IBM is finally growing again, even as it faces tough macroeconomic and currency headwinds. Analysts expect its revenue and earnings to each grow about 4% this year. The company’s stock also looks dirt cheap at just 13 times forward earnings, and it pays an attractive forward yield of about 5%.

Big Blue trails Coca-Cola and J&J with a total return of 176% over the past two decades, but it could easily deliver bigger gains over the next two decades with its newly streamlined business.

— Leo Sun

Source: The Motley Fool