Forget Procter & Gamble, Here's a Better Dividend Stock to Buy

By Markets Fool.com

Consumer staples giant Procter & Gamble enjoys a strong (and well-deserved) reputation among income investors. It has paid dividends for 125 consecutive years, dating all the way to the company's incorporation in 1890. What's more, P&G recently increased its payout for the 59thyear in a row.

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The company is a Dividend Aristocrat, and the stock offers a solid 3% yield. but it's also true that P&G's dividend growth has slowed significantly in recent years. The company's growth has ground to a halt, due most recently to a brutal currency headwind.

For these reasons, dividend growth investors might want to consider one of P&G's biggest rivals, Colgate-Palmolive , as a better dividend stock.

P&G is relying on its reputation
Procter & Gamble has distributed more than $55 billion in dividends to its investors over the past decade. This has cemented the company's reputation, but there are significant cracks in P&G's dividend armor. This year, the company only increased its dividend by 3%. While a raise of any kind is enough to sustain its streak of annual increases, a 3% bump is barely above inflation.

Of course, a big reason why P&G can't increase its dividend at higher rates right now is because its sales and earnings aren't growing fast enough. Over the first two quarters of its current fiscal year, net sales and earnings from continuing operations declined 2% and 7%, respectively, year over year. Not surprisingly, currency was responsible. Foreign exchange shaved 5 full percentage points off P&G's sales just last quarter.

P&G generated $5.4 billion of free cash flow in the second quarter. In the same period, the company distributed $3.6 billion in dividends, resulting in a 67% free cash flow payout ratio. That's right in line with the company's history over the past several years.

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But P&G is also partly to blame for its weak dividend raise. The company spends a large amount of money on share repurchases. For example, P&G spent $4.2 billion buying back its own stock in the first two fiscal quarters. This accounted for 77% of P&G's free cash flow. The company can afford to pay dividends and buy back stock because it is flush with cash after $3.6 billion in asset sales over the first two fiscal quarters. With such an aggressive share repurchase program, though, P&G did not have much room to pass along a more significant dividend increase.

A better dividend growth stock
By contrast, Colgate-Palmolive is rewarding shareholders with stronger dividend increases. It increased its payout by 6% this year, roughly double P&G's 2015 raise.Colgate-Palmolive can be more generous with its dividend increases than P&G because it spends much less on share buybacks.

In 2014, Colgate-Palmolive generated $2.5 billion of free cash flow. It paid $1.4 billion in dividends in that time, for a more modest 56% free cash flow payout ratio. Moreover, the company spent just $1.5 billion on share buybacks. Importantly, Colgate-Palmolive nearly covered both its dividend and share repurchases with free cash flow.

Procter & Gamble stock yields 3.1%, which is higher than Colgate-Palmolive's 2.3% yield. This gives it an advantage for investors who need more income right now. But with time Colgate-Palmolive's higher dividend growth should allow it to catch up to P&G. This is a key factor for dividend growth investors to keep in mind.

The key takeaway is that P&G remains a Dividend Aristocrat, but the company is only able to increase its dividend by small amounts, partly due to a tough currency headwind. But Colgate-Palmolive is facing the same currency pressures and managed a bigger dividend increase. P&G could easily shift its capital allocation program to spend more on dividends and less on buybacks, but so far has not done so. Colgate-Palmolive has decided not to splurge on buybacks, and as a result, stands as the better dividend stock of the two.

The article Forget Procter & Gamble, Here's a Better Dividend Stock to Buy originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.