Other than being dividend stocks, what do Pepsi (NASDAQ:PEP) and Fortis (TSX:FTS)(NYSE:FTS) have in common?
The dividend stocks have resilient earnings. They are Dividend Aristocrats with a track record of dividend increases. Pepsi and Fortis pay dividends that are sustainable. They offer nice yields of about 3-4%
I use a method that suggests good stock price ranges to buy this type of dividend stocks at. Recently, I have used exactly this method to buy shares of Pepsi and Fortis. I’ll explain the method later in this article. First, let’s go through the above commonalities in more detail.
The graphs below show Pepsi stock and Fortis stock as companies with resilient earnings. They clearly show their earnings stability through economic cycles.
Over the last 20 years or so, there were very few years in which they experienced earnings decline. Even when there were declines, the declines were small. And they’re able to recover the earnings and resume growth fairly quickly.
Other than having earnings that tend to grow over the years, Pepsi and Fortis keeping their payout ratios sustainable is another reason they have maintained long and healthy streaks of dividend increases.
Pepsi has increased its dividend for 49 consecutive years. Its payout ratio was 73% in 2020. This is a sustainable payout ratio given the quality of its earnings.
PEP’s five-year dividend growth rate is 7.8%. Currently, it’s estimated to grow its earnings per share by about 8% per year over the next three to five years. So, I expect its dividend to continue growing in the 7-8% range in that period.
Fortis’s dividend has climbed for 47 consecutive years. Its 2020 payout ratio was 75%. Again, this is sustainable given its earnings stability.
Fortis’s five-year dividend growth rate is 6.8%. Management forecasts to grow its dividend annually by about 6% through 2025. Given the regulated nature of the utility, there should be no suspense there.
When Should You Buy Dividend Stocks like Pepsi or Fortis?
Businesses change over time. I find that looking at the five-year dividend yield history of dividend stocks like Pepsi and Fortis provides good price ranges for entry.
The chart below illustrates that dividend-growth stock, Pepsi, tends to reach a yield of about 3.2% before the yield comes back down, which is when the stock price goes up.
PEP Dividend Yield data by YCharts
Fortis’s case is similar, except its yield point is about 4%.
FTS Dividend Yield data by YCharts
You’ll notice that I’m not trying to buy the dividend stocks at the best prices. If I try to aim for the lowest prices and highest yields, I might miss the buying opportunities. Instead, my goal is to buy them at attractive prices and yields.
With this method, along with some other tools I use for analysis, I bought
- Pepsi stock at $131.62 per share for an initial yield of 3.1% on March 1, 2021, and
- Fortis stock at CAD$49.05 per share for a starting yield of 4.1% on February 26, 2021
I alerted these trades in real time to my subscribers here.
Wait… Pepsi’s yield wasn’t at 3.2%, but I bought it anyway. Was I not disciplined enough? Nope, it’s just that I was eyeing PEP’s dividend increase that’s expected by May, which is coming real soon. As long as it hikes the dividend by at least 3%, I’ll get that minimum target yield of 3.2%.
I’m also happy to share that Fortis will also increase its dividend soon-ish; it’s expected to declare a dividend increase in September.
This method is working beautifully for these trades already. As of writing, that is, within a month, Pepsi stock has appreciated 8.4% to $142.70, while Fortis stock is up 11.5% to CAD$54.70. Recall that the long-term average market returns are 7-10%. That’s the market return right there!
With dividend-growth stocks like Pepsi and Fortis that have a track record of stable earnings and sustainable dividends, you can explore the five-year yield history method to determine if they’re good buys.
Remember that you’re not trying to get the best prices because doing so could make the opportunity slip away from you. Securing a buy at attractive prices/yields should suffice for satisfactory income and returns.
Notably, this method will break down in extreme market conditions, such as during market crashes. However, if you use this method for the discussed type of defensive dividend stocks, your investment should still do well over a long-term investment horizon.