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Dividend stocks provide the opportunity for consistent income for risk-averse investors. But not all dividend stocks are equally good, and I prefer to find stocks with steadily increasing dividends and wide moats. Three great stocks that come to mind: Johnson & Johnson (NYSE: JNJ), Realty Income Group (NYSE: O), and CVS Health (NYSE: CVS). Here's why I believe each is a great holding over the long term.
Not what it appears
Johnson & Johnson is a Dividend Aristocrat, or a dividend stock that has been increasing its payout annually for more than 25 years. In J&J's case, it's met this threshold two times over. While most people know it for its consumer products, like Band-Aids, Tylenol, and baby shampoo, J&J is actually a heavily diversified healthcare company. Those consumer brands only made up roughly 18% of second-quarter 2016 revenue, with pharmaceuticals contributing 47%, and medical devices the remaining 35%.
That diversification is an enormous benefit to the company, as the sleepier medical device and consumer products divisions can provide the company with strong cash flow while its more boom-and-bust pharma division drives higher growth for the company. Having recently completed the acquisition of Vogue International for its consumer division, management is now seeking opportunities in med tech and pharma -- although none appear to have materialized yet.
In the meantime, keep an eye on J&J's drug portfolio, as that's the easiest lever for growth the company has. I'd pay special attention to cancer drug Imbruvica as it expands into new indications, and multiple myeloma drug Darzalex, which was recently brought to market. Company management expects both to be big potential wins for the company's top line going forward.
Add in J&J's cash dividend payout ratio of just 60%, and according to data from S&P Global Market Intelligence, J&J is in a superb position to continue paying out a growing dividend -- currently yielding 2.7% -- for many years to come.
The retail star
Realty Income Group, the real estate investment trust (or REIT) that's known as "the monthly dividend company," has been significantly more active on the acquisitions front than J&J. Realty Income's management recently raised their guidance to $1.25 billion in acquisitions for 2016 because they see so many opportunities to buy property and expand its lease base. And the reason why is obvious: Interest rates are low, so the cost of borrowing is low, and REITs like Realty Income can more cheaply fund acquisitions and grow their profitability and diversification.
And boy, has Realty Income grown. So much so that it has raised its dividend for 75 consecutive quarters. And with its most recent raise, the company has grown its monthly dividend by 6.1% compared to a year ago. Fortunately, that dividend growth has been largely matched by growth in the company's adjusted funds from operations, or AFFO -- (here's a good article to learn more about FFO, the number from which AFFO is derived) -- so the current payout ratio based on AFFO is around 85% for a 3.6% annual dividend yield.
Realty Income's big advantage is its low cost of capital -- a function of its size and high credit rating -- which should give it a big leg up on the competition when interest rates finally increase. Bottom line: Realty Income isn't going anywhere, and it's a great long-term holding in anyone's portfolio.
CVS Health is well known as a retail pharmacy, but people seem to forget the larger (by revenue) component of its business: the pharmacy benefit manager (or PBM), which brought in 68% of revenue last quarter. While the retail side has been growing, the PBM is on fire. So far in this year's selling season, it's brought in a whopping $4.6 billion in net new business.
CVS's big moat is the fact that it's an integrated healthcare company. Unlike, say, a Walgreens or Express Scripts, it's a pharmacy, a clinic manager, a mail-order pharmacy, and a PBM -- enabling it to serve patients across a number of different health circumstances and challenges.
This move toward vertical integration is expensive, and necessitated purchases of home-infusion specialist Coram, long-term care facility pharmacy provider Omnicare, and Target's in-store pharmacies over the last year, but it's paying off in spades. With revenue up 18% year over year and adjusted EPS up 8.3% last quarter, CVS is doing a great job of integrating these purchases and building up its business. And with a dividend yielding roughly 1.9% (and a low 25% cash payout ratio based on the trailing 12 months), CVS has plenty of room to pay ever-growing dividends for years to come.
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Michael Douglass owns shares of Johnson and Johnson. The Motley Fool owns shares of Express Scripts. The Motley Fool recommends CVS Health and Johnson and Johnson. 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.