Dividend growth stocks are attractive buyout targets

Most of the companies which leave the dividend achievers or the dividend aristocrat indexes do so because of three reasons. Firtst, they might stop raising dividends because they needed cash for acquisitions. Another reason is that companies cut distributions because of poor economic conditions or need for cash in acquisition. The third reason why companies are booted out of these elite dividend indexes is because they are being acquired or have merged with another company.

Some of the best dividend stocks have raised distributions for many years in a row. This could only be achieved if they had a solid business model, and a durable competitive advantage which prevents barriers to entry and allows the company to maintain a loyal customer base. Dividend stocks could be found in many industries including pharmaceuticals, telecommunications, utilities, financial services and consumer staples to name a few.

While some investors believe that a company should plow back all of its earnings into the business, some of the most successful companies which incidentally boast a long record of dividend raises have proven otherwise. Companies such as Wal-Mart Stores (WMT) or Automatic Data Processing (ADP) have managed to not only grow their business successfully for many decades but also to reward long-term stockholders with a regularly rising payout. Maintaining a proper balance between overexpansion and rewarding shareholders is an important component of sound corporate policy, which takes into account the interests of a variety of stakeholders. Paying a dividend instills a discipline to managers, and thus makes them more careful about accepting projects which might not contribute to the bottom line.

The problem with many dividend stocks is that they could be attractive buyout targets by larger rivals or by companies which are looking to diversify into a new line of business. Shareholders usually receive a big premium which ensures that almost everyone makes a profit in the process. This doesn’t take into consideration the fact that a growing company might deliver much higher total returns if it stayed independent.

Two recent examples of solid dividend stocks which are in the process of being acquired are Cadbury (CBY) and Alcon (ACL). Both stocks are members of the elite international dividend achievers index.

Alcon (ACL) is one of the biggest players in the global market for eye-care products, specializing in surgical equipment and devices, contacts lens solutions and other consumer eye-care products. The company has raised dividends for 6 consecutive years. Swiss food giant Nestle purchased the company in 1977 for $280 million. So far Nestle is going to make about $40 billion in total from selling its whole stake to Novartis (NVS). The extra cash that Nestle would receive would be used for share repurchases or it could be used to bid for Cadbury (CBY).

Cadbury plc, (CBY) together with its subsidiaries, engages in the confectionery business worldwide. It has raised dividends for 12 consecutive years. The company's board has approved Kraft Food’s (KFT) acquisition of Cadbury. There were rumors that Hershey (HSY) and Nestle would likely team up to bid against Kraft for the maker of chocolate and gum.

Other notable dividend achievers which were acquired include Gillette, which was purchased by Procter & Gamble (PG) in 2005, Quaker Oats acquired by PepsiCo (PEP) in 2001 and Geico, which was acquired by Berkshire Hathaway (BRK.A) in 1996.

It is interesting to note that the companies which have been acquired have continued to deliver strong revenues and earnings for the companies which acquired them in the first place. In the event that a dividend achiever or aristocrat is being acquired by another dividend achiever or aristocrat in stock, it might be beneficial to keep the stock of the acquirer. The key factor is for the acquirer to keep raising distributions.

Full disclosure: Long ADP, PEP, PG and WMT

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