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Looking for extra income? Consider more than current yield

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The past few years have not been good for people seeking income from their investments.

The last time the 10-year T-note regularly yielded 4% was before the 2008 financial crisis. Even if the Fed tightens again by the end of the year, bond yields are likely to move up only slightly.

Long gone are the days when advisers could count on ultra-safe Treasury securities to provide both stability and income for client portfolios. And though many investors fear dividend-paying equities have become overextended, they have helped erase some of that income deficit.

Dividend-oriented funds and ETFs may help to mitigate individual stock risk, but they can dilute income growth potential by including many issues that increase dividends only slightly or not at all.

To give clients extra income, consider adding to the diversified portfolio by investing in a group of stocks likely to provide a good yield on cost. While most investors look at a stock’s current yield (indicated dividend/current price), yield on cost (indicated dividend/cost of investment) provides a much more meaningful assessment of the income a portfolio is generating.

While it’s not difficult to find dividend-paying equities (more than 80% of issues in the S&P 500 pay), stocks that provide good yield on cost are far less common.

Two that stand out when their current indicated dividends are measured against the median share price a decade ago are Sherwin-Williams (SHW) and Church & Dwight (CHD).

Sherwin-Williams is North America’s biggest paint manufacturer. Although SHW’s indicated dividend of $3.36 a share results in a current yield of about 1.2%, investors who bought the stock at the 2006 median share price of $51.08 are enjoying a robust yield on cost of 6.6%. What’s more, the company has increased its dividend for 38 consecutive years. Value Line estimates that SHW will boost its payment 12% annually in the coming five years.

Church & Dwight, the maker of Arm & Hammer brand household products, also has a modest current yield of 1.5%. But based on its 2006 median share price (adjusted for splits), CHD yields 7.5% for people who bought it back then . The company has boosted its shareholder payments 27% annually over the past decade, but Value Line projects more subdued 4% annual increases over the next five years.

Where do you find companies that are likely to produce good yield on cost? One way is to focus on those companies that recently initiated dividends.

Carter’s (CRI) is a good example. The maker and seller of children’s clothing under the Carter’s and OshKosh B’gosh brands went public in 2003 and paid its first dividend a decade later. The current indicated rate is $1.32, which represents a 175% increase from the actual payment in 2013. Cash flow is growing well and in a press release earlier this year, Carter’s CEO noted the company’s “continued commitment to return capital to our shareholders.”

Amgen (AMGN) is another recent dividend-paying convert. The biotechnology giant began paying its shareholders in 2011. Holders will receive $4 a share in 2016, up a whopping 614% from what they got five years ago. In the company’s 2015 annual report, the CEO committed to returning approximately 60% of Amgen’s adjusted net income to shareholders through 2018 via dividends and buybacks.

Do the words and actions of Carter’s and Amgen guarantee that they will continue to increase shareholder dividends? No, but companies that begin a robust dividend program usually continue along that path.

Problems at the companies or in the economy (think the financial crisis) can disrupt things, but a well-chosen group of new dividend increasers can give clients a good future yield on cost.

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