Dividend-Growth Stocks to Watch

Investors who wouldn't mind getting a check or two in the mail from their stock portfolios can breathe a sigh of relief. Although President Bush's ambitious plan to eliminate double taxation of corporate dividends didn't make it through, investors will now pay a tax rate of 15% on stock dividends, instead of paying taxes at much higher ordinary-income tax rates. That makes dividend-paying stocks more attractive for taxable accounts than they've been in the past.

For this week's Five-Star Investor, we'll focus on stocks that have a proven record of boosting their dividends over time, as well as the financial resources to continue paying dividends in the future. To start, we used Morningstar's  Premium Stock Screener to screen for companies with yields of at least 2%. That doesn't sound like much, but it's better than the average for the S&P 500, which is about 1.6%.

We also limited the field to companies that have raised their dividends in each of the past four years, as well as over the past 12 months. To make sure those dividends are sustainable, we homed in on firms with a consistent record of positive free cash flows over the past five years, as well as financial health grades of at least B. Finally, we limited the universe to companies with returns on equity greater than 15%. That eliminated some dividend-paying firms that have stumbled lately, such as  Rohm and Haas (ROH) and  DuPont . All told, about 27 stocks made the final cut.

Unfortunately, not many of the stocks on this list are great bargains right now after the recent market rally. We'd recommend that investors wait until the shares drop below our fair value estimates before stepping up to the plate.

Here are some highlights (Morningstar ratings and dividend yields as of May 29, 2003): 

 Schering-Plough 
Dividend Yield: 4.45%
Morningstar Rating: 4 Stars
From the  Analyst Report: "We expect layoffs, management attrition, and legal settlements to be the headliners over the next few months, but Schering-Plough has the financial wherewithal and product lineup to rebound, in our opinion. Investors looking for a pharmaceutical fixer-upper have one in Schering-Plough, but we'd wait for the shares to dip below $18 before buying."

 3M Company (MMM)
Dividend Yield: 2.02%
Morningstar Rating: 3 Stars
From the  Analyst Report: "As (CEO James) McNerney continues to unlock value for shareholders, 3M's stock price has surged, easily trumping the market over the past two years. Our fair value of $115 indicates the stock is currently overpriced. We'll keep 3M on our radar screen and wait patiently for the right time to invest."

 Clorox (CLX)
Dividend Yield: 2.02%
Morningstar Rating: 3 Stars
From the  Analyst Report: "Clorox's products either wear out or get used up, so demand for them exists as long as things get messy. Clorox is a stock for the long haul, though we'd seek at least a 30% discount to our fair value estimate before investing."

 Eli Lilly & Company (LLY)
Dividend Yield: 2.16%
Morningstar Rating: 3 Stars
From the  Analyst Report: "Lilly was built on the back of synthetic insulin and Prozac, but now the company derives less than 20% of its sales from these franchises. Management is laying new foundations in areas like osteoporosis and cancer that convince us of the firm's research-oriented spirit. We think Lilly is a good drug company to invest in at the right price."

 ExxonMobil (XOM)
Dividend Yield: 2.52%
Morningstar Rating: 3 Stars
From the  Analyst Report: "If we had to choose our favorite company in the energy industry regardless of price, ExxonMobil would be at the top of the list. However, price does matter, so we are merely keeping the company on the radar for now and waiting for a dip before buying." 

 Kimberly-Clark (KMB)
Dividend Yield: 2.41%
Morningstar Rating: 3 Stars
From the  Analyst Report: "We think Kimberly-Clark is better positioned than its peers to cope with prolonged economic mediocrity. However, the company still faces strong competitors as well as consolidation in the retail industry. We'd require at least a 30% margin of safety to our fair value estimate before investing."

 Merck (MRK)
Dividend Yield: 2.57%
Morningstar Rating: 3 Stars
From the  Analyst Report: "Merck remains one of a handful of companies on the planet with a triple A credit rating, and it has the reputable research department to back up claims that it will discover novel medicines to treat unmet medical needs. Merck should find its way again, but we think it will have to do so with lower margins and tougher competitors breathing down its neck. We'd be buyers only in the low $40s."

Click  here to run this screen yourself and see all the stocks that passed. (Note: You will need to be a Premium Member to view and save the complete screen.) After clicking, you can save the screening criteria by using the "Save Criteria" button in the bottom right-hand corner of the screen.