2 Outstanding Dividend King Stocks and 1 ETF to Buy for a Lifetime of Passive Income

The truth is, no one knows if a company has what it takes to reward its investors with a lifetime of passive income. But there are criteria you can use to determine the durability of a dividend-paying company or exchange-traded fund (ETF).

One factor is a company’s history of paying and raising its dividend. American States Water (AWR -0.02%) and Illinois Tool Works (ITW -0.17%) are both Dividend Kings — meaning they have paid and raised their dividends for at least 50 consecutive years — a track record that showcases their ability to grow earnings and pass along growing profits to shareholders through dividends.

Meanwhile, the JPMorgan Nasdaq Equity Premium Income ETF (JEPQ -0.51%) is a unique, ultra-high-yield investment that uses financial instruments to generate income primarily from growth stocks.

Here’s what makes these two Dividend Kings and this ETF great buys now.

American States Water is a regal choice for bolstering passive income streams

Scott Levine (American States Water): Finding companies that have continued hiking their dividends for nearly seven decades is hardly a common occurrence, but that’s exactly what American States Water represents. And for those who question that the company will soon falter in its ability to extend the streak, it’s best to think twice as there are plenty of reasons to believe that the water utility stock will continue boosting its payout for many years to come. For income investors looking to bolster their passive income streams, Dividend King American States Water — along with its 2.2% forward-yielding dividend — is a great opportunity.

A large part of why American States Water is so successful at returning capital to shareholders via the dividend is that the company primarily operates in regulated markets. In 2023, for example, the company’s regulated businesses represented 80% of its overall revenue. Although the company can’t arbitrarily raise rates for its water and wastewater services, it is guaranteed certain rates of return. This gives management clear foresight into future cash flows, enabling it to plan accordingly for capital expenditures such as infrastructure upgrades, acquisitions, and dividends.

With its recently announced dividend hike, American States Water has boosted its dividend for 70 consecutive years. And these aren’t nominal increases, either. Over the last five years, American States Water has boosted its quarterly dividend at an 8.8% compound annual growth rate — a period during which it has averaged a payout ratio of 57%, illustrating, in part, how management’s insight into cash flows can help it return capital to shareholders without jeopardizing the company’s financial well being.

Since there’s no drastic change to the company’s business model in the works, the company will likely keep on keepin’ on — generating steady cash flows and boosting its dividend for years to come.

ITW deserves to be at an all-time high

Daniel Foelber (Illinois Tool Works): Illinois Tool Works, commonly known as ITW, hit an all-time high on Monday. And there are plenty of reasons to believe it is still a good buy.

ITW is basically several different businesses under one umbrella. The industrial conglomerate operates seven segments — automotive, food equipment, test & measurement and electronics, welding, polymers & fluids, construction products, and specialty products. And each segment is home to many if not dozens of brands.

In the recent quarter, no single segment made up more than 21% of revenue, and every segment had an operating margin over 23% except for automotive, which had a 19.4% margin. ITW is a textbook example of the advantages of the industrial conglomerate model. On their own, all of ITW’s segments have some cyclicality. However, under one company, they can help smooth out volatility and diversify the broader business while benefiting from synergies such as reduced administrative costs.

ITW’s success with the industrial conglomerate model is impressive, considering some noteworthy players are moving away from that model. GE spun off into three different businesses. And an activist investor recently proposed that Honeywell International split its aerospace segment from the rest of the business.

With a price-to-earnings (P/E) ratio of 23.9, ITW looks like a good value at first glance. But the earnings are a bit misleading, as ITW benefited from a divestiture gain of $1.26 in the recent quarter. ITW is guiding for $11.63 to $11.73 in full-year earnings per share. Taking out the one-time divestiture gain, the adjusted figure would be $10.42 at the midpoint — giving ITW a P/E ratio of 26.5 based on the stock price at the time of this writing and assuming it hits its guidance. For context, ITW’s median P/E ratio over the last three to 10 years has been 23.4 to 24.6.

ITW is a bit pricey, but it deserves a premium valuation. ITW is one of the few major industrial companies with virtually no major issues over the last five years. Even during the height of the pandemic, sales fell by a manageable level, and margins remained in the low 20% range.

ITW Revenue (TTM) data by YCharts

As you can see in the chart, ITW has continued to grow its operating margin and revenue. It has passed profits back to shareholders through a blend of buybacks and a growing dividend. Over the last decade, ITW has reduced its share count by 22.9% thanks to buybacks — an extremely impressive pace that few other industrial behemoths could hold a candle to.

In sum, ITW checks all the boxes for a dividend stock you can buy for a lifetime of passive income. The valuation isn’t cheap, and the yield is only 2.2%, but ITW makes up for these drawbacks with its high-quality business and multipronged capital return program that includes buybacks and dividends.

An ETF that gives you exposure to tech stocks and a high yield

Lee Samaha (JPMorgan Nasdaq Equity Premium Income ETF): One of the problems of investing in high-yield stocks is that it tends to result in an unintended sector or style bias manifested in your portfolio.

In plain English, you might end up with a portfolio overloaded with stock in a sector that happened to trade on high yields at the time, such as oil and gas exploration and production companies. Similarly, high-yield equities often have certain characteristics, such as being low-growth mature “cash cow” type companies.

Both outcomes are fine for many investors, but this JPMorgan ETF might be the answer for investors who prefer a more flexible approach. The ETF invests 80% of its assets in equities. The prospectus claims it invests “significantly” in Nasdaq-100 equities, but management has the latitude to also invest in equities outside the Nasdaq-100 index.

The key point is that management actively manages the ETF to invest in growth stocks, and the dividend yield is not a priority.

The main income generator of the ETF comes from its investment (up to 20% of the ETF’s assets) in equity-linked notes (ELN) that sell call options on the Nasdaq-100. As such, the ETF picks up a premium when the index falls or doesn’t rise above the strike price on the option.

The option strategy will lose money when the markets are on fire but earn premiums when they are relatively quiet or declining. As such, the upside of the ETF is limited (although it’s still likely to appreciate if tech stocks are doing well), but so is the downside. However, investors will simultaneously receive a monthly distribution, exposure to growth stocks, and a handsome dividend.