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All Contents © 2019The Kiplinger Washington Editors
By Lisa Springer, Contributing Writer
| June 8, 2018
If you’re an investor losing sleep over big market price swings, one of the best ways to protect your portfolio is to own dividend growth stocks. Reliable, regular dividend hikes boost cash payments to investors and create a cushion that limits the effect of market downturns.
Better still, steadily rising payouts increase “yield on cost” – the current dividend divided by the original cost of the investment – which means even a small yield now could become far more substantial over time.
Dividend growth stocks help insulate portfolios from volatility because of the portion of total returns that the income distributions represent over long periods. For instance, depending on the study, dividends are believed to account for somewhere between 60% and 70% of the Standard & Poor’s 500-stock index’s total returns over time.
To deliver consistently high dividend growth, companies must have proven business models, increasing profits and cash flows and a solid balance sheet. Importantly, they need to have plenty of room in their profits to grow the dividend – companies that already pay out high percentages of their earnings can’t aggressively hike their dividends without putting their financial stability at risk.
Here are 10 dividend growth stocks that have the business models and financial strength necessary to deliver many years of double-digit payout expansion.
Data is as of June 7, 2018. Dividend yields are calculated by annualizing the most recent quarterly payout and dividing by the share price.
Market value: $78.6 billion
5-year dividend CAGR: 24.0%
Dividend yield: 2.0%
Starbucks (SBUX, $57.14) cafes serve more than 75 million customers a month. The company’s recently launched rewards program has already attracted more than 15 million members and helped fuel 8% U.S. sales growth last quarter.
China is another key driver of Starbucks growth. No Western brand is better positioned to benefit from China’s expanding middle-class than Starbucks. China’s middle class is expected to double over the next five years to 600 million, or roughly twice the total U.S. population. China sales rose 54% last quarter and Starbucks remains on-track to open 600 new stores in China this year.
Starbucks recently sold its packaged coffee brands business to Nestle (NSRGY) for $7.2 billion in cash. It also has committed to returning $20 billion to investors over the next three years through dividends and share repurchases.
The company has grown its annual payout for eight consecutive years, and at a 24% clip for the past five. This high growth has resulted in an attractive yield on cost of 3.7% for investors who bought five years ago. The payout is modest, too, at just 36% of profits, leaving plenty of room for dividend growth.
Wedbush analyst Nick Setyan recently rated these shares “Outperform” and expressed confidence in Starbucks’ ability to hit same-store sales growth targets this year.
Market value: $777.8 billion
Dividend yield: 1.6%
5-year dividend CAGR: 15.2%
Microsoft (MSFT, $100.88) is a longtime software powerhouse, but the catalyst for the tech giant’s future growth is cloud services. During the company’s recently reported fiscal third quarter, service revenues from Azure, Microsoft’s cloud business, grew by triple digits for the 15th consecutive year. Overall, Azure revenues climbed 93% year-over-year.
Over the past 12 months, Microsoft has added over 130 new capabilities for Azure. New cloud offerings and major initiatives underway in the areas of Artificial Intelligence (AI) and the Internet of Things (IoT) should support continued robust growth in the years ahead.
New products Microsoft is developing include Azure IoT-equipped commercial drones with on-board cloud-based AI, IoT and AI-equipped cameras, Azure conversational AI that allows seamless interfacing between Facebook, Alexa and Cortana, and Azure Sphere, a scalable IoT security solution that provides simultaneous cloud and device security for up to nine billion compute nodes.
JPMorgan analyst Mark Murphy recently upgraded his Microsoft rating to “Overweight,” in fact, citing exactly that: a successful cloud strategy and a powerful new lineup of cloud solutions.
Microsoft generated $39.5 billion of cash from operations last year and returned $22.3 billion to investors through dividends and share repurchases. So far in 2018, MSFT has produced $32.4 million of cash from operations and returned $17.8 billion to investors.
Microsoft began paying dividends in 2004 and has increased the rate steadily over time, including an 8% hike this year. Its payout ratio typically remains in the 50%-60% range – that’s a bit higher than other stocks increasing their dividends at similar rates. But the payout is well-supported by strong EPS growth and sizable cash flows.
Market value: $81.3 billion
5-year dividend CAGR: 21.5%
Dividend Yield: 1.7%
Lowe’s (LOW, $99.27) is America’s second largest home improvement retailer – behind rival Home Depot (HD) – with nearly 2,400 stores nationwide. Despite its huge franchise, Lowe’s has so far penetrated only 10% of the home improvement market, leaving ample opportunity for growth.
Lowe’s opened 25 stores in 2017 and plans to open 10 more stores this year. The company also is increasing the average size of sales transactions, which grew by 4.2% last year, by enhancing penetration of the professional remodeler segment, which has grown from 25% to 30% of sales.
Job gains and income growth are fueling expansion of the do-it-yourself home improvement segment. In addition, rising home prices encourage homeowners to spend more on remodeling. Spending on professional remodeling is forecast to grow 7.5% this year.
Lowe’s has raised dividends 54 years in a row, including a 19% hike last year. With dividend payout at 39% and annual free cash flow twice dividends, investors can look forward to rising dividends in the future.
Wells Fargo analyst Zachery Fadem initiated coverage of Lowe’s in April with a rating of “Outperform,” citing a macro-economy working in the retailer’s favor and strong prospects for market share gains.
Market value: $113.5 billion
Dividend yield: 1.9%
5-year dividend CAGR: 12.7%
Honeywell International (HON, $152.09) is a diversified industrial concern with significant operations spanning aerospace, performance materials and industrial software, among myriad other things. Its products are used on virtually every aircraft, more than 150 million homes and over 10 million commercial buildings worldwide.
A major growth driver for Honeywell is warehouse automation software. Honeywell acquired Intelligrated, a leader in warehouse automation technologies, two years ago and has grown this business 20+% annually. Demand for warehouse automation software is growing due to the rise of e-commerce giants like Amazon (AMZN) and Walmart (WMT).
Honeywell is a cash flow machine, generating more than $4.9 billion of free cash flow last year, which was used for acquisitions, share repurchases and dividends.
Shares yield less than 2%, so Honeywell is easily overlooked by income investors. The thing is, the yield is so low because HON shares have performed so well. The company has grown its dividend by more than 80% over the past five years, but the stock has roughly doubled in that time. Honeywell also targets 10%-13% dividend growth in 2018.
Among the 20 analysts currently following Honeywell, 80% rate the stock a “Buy,” and none recommend selling shares.
Market value: $23.8 billion
Dividend yield: 2.3%
5-year dividend CAGR: 13.9% /13.6%
Corning (GLW, $28.81) was founded on glassware, but today the business is more focused on smartphones and fiber optics. Corning is the world’s leading producer of glass for LCD displays used in flat-screen TVs and smartphones, and it dominates the market for fiber optical cable used to build high-speed data networks.
At present, Corning businesses are running at full capacity. The company has expansion initiatives underway, though, including a new LCD glass manufacturing facility in China, which will enable production volume to keep pace with rising demand..
Over the next three years, Corning has committed to returning $12.5 billion to shareholders and growing dividends at least 10% a year. The company generates over $2 billion of cash flow annually and has $3 billion in cash, sufficient to cover three years of dividends.
Corning has raised dividends eight years in a row, including a 15.2% increase last year. Payout from core EPS ranges around 40%-50%, allowing for dividend growth in the years ahead.
Market value: $113.5 billion
5-year dividend CAGR: 21.5% / 17.23%
Texas Instruments (TXN, $117.24) is a leading designer, manufacturer and marketer of semiconductors. Approximately 100,000 customers worldwide use the company’s chips.
Competitive advantages such as in-house manufacturing, 40% lower wafer manufacturing costs than competitors, a broad product portfolio and world-class sales capabilities enable Texas Instrument to generate sizable cash flows even during industry downturns.
Near-term growth will come from automotive and industrial applications for the company’s products. New automotive features like driver-assist and collision avoidance increase the semiconductor content of cars. In the industrial segment, smart appliances and robotic assembly lines require more semiconductors.
Texas Instrument generated free cash flow exceeding $4.7 billion last year, and it ranked among the top 15% of S&P companies based on its ability to convert 30% to 40% of revenues to free cash flow. Better still, the company’s payout has grown for 14 consecutive years, including a 27.3% increase last year.
Jefferies analyst Mark Lipacis issued a “Buy” recommendation and recently added Texas Instruments to Jefferies’ “Franchise Pick List”.
Market value: $205.1 billion
Dividend yield: 2.8%
5-year dividend CAGR: 26.4%
Cisco Systems (CSCO, $43.49) is successfully transitioning from switches and routers to software and subscription-based services that generate high recurring revenues. The company’s new subscription-based switching platform, Catalyst 9000, has been the most successful product launch in its history, with a customer base nearly doubling every quarter.
As a result of these new products, recurring sources now account for roughly one-third of Cisco’s revenues. Deferred revenues from recurring software and subscriptions rose 29% last quarter and exceeded $5.6 billion.
Cisco is making acquisitions to gain footholds in new segments such as AI, cloud computing and IoT. Recent purchases include Accompany, a maker of AI tools for sales prospecting, Broadsoft, which has cloud-based products for unified communications, and AppDynamics, a developer of software for remotely monitoring mobile apps and websites.
Cisco repatriated approximately $67 billion of cash from overseas last year, and after spending on acquisitions $54.4 billion remains available for future M&A, share repurchases and dividend growth.
CSCO has grown dividends seven years in a row, including a 13.8% hike last quarter. Payout from its strong cash flow is modest at 30%-40%. The yield on cost for Cisco shares bought five years ago is impressive at 5.5%.
Baird analyst Jayson Noland rates these shares “Outperform” and recently noted that Cisco is increasingly differentiating itself from its competitors.
Market value: $1.37 billion
5-year dividend CAGR: 24.6%
Neenah (NP, $81.25) is the world’s leading maker of specialty paper products for automotive and truck filters, industrial filters, premium packaging and graphic imaging. Proprietary formulations, broad technical capabilities and a global footprint have enabled Neenah to build a 60+% share in high-margin graphic imaging markets.
Global capacity remains tight in filtration products and Neenah is increasing its volume with a new production facility in the U.S. The company anticipates a ramp similar to its European plant, which grew from zero to $80 million in sales in five years. In addition, Neenah recently closed acquisitions that expand its capabilities in premium packaging and digital transfer media. The Coldenhove acquisition in November made Neenah the dominant player in fast-growing digital transfer markets.
Five-year EPS growth has averaged 10% per year and cash flow generation has exceeded $100 million three years in a row, enough to cover four years of dividend payments.
Neenah raised the dividend 11% in 2018, marking its eighth consecutive year of double-digit dividend growth.
Market value: $4.1 billion
5-year dividend CAGR: 22.0%
Penske (PAG, $49.52) is the country’s second largest automotive retailer behind AutoNation (AN). The company owns 343 car dealerships and sold 619,000 vehicles last year. Other Penske assets include 20 heavy-duty truck dealerships across North America and engines and power train distributorships in Australia and New Zealand.
Penske specializes in premium automotive brands like Audi, BMW, Mercedes-Benz and Porsche that are less cyclical and support premium sales margins. Cyclical risk is further reduced by the company’s geographical diversification and highly profitable repair and parts businesses, which contribute more than 40% of gross profits.
Penske is a consolidator in a higher fragmented dealership market. Last year, the company added $500 million of sales by acquiring premium new car dealerships in the US and Europe. Two used car dealerships (U.S.-based Car Sense and U.K.-based Carshop) added another $710 million to sales and M&A activity continued this year with the purchase of a northern England dealership (The Car People) that generates $300 million of annual revenues.
Penske has made 28 consecutive quarterly dividend increases. Dividends rose 14% last year. With a payout ratio of only 18%, there is ample room to grow dividends.
Guggenheim analyst Ali Faghri initiated coverage in April with a “Buy” rating. This follows a February upgrade to “Buy” from Bank of America analyst John Murphy and a March upgrade to “Overweight: by Morgan Stanley analyst Adam Jones.
Market value: $11.29 billion
Dividend yield: 2.1%
5-year dividend CAGR: 19.6%
Packaging Corporation of America (PKG, $120.66) is North America’s fourth largest producer of containerboard and corrugated packaging and the third largest producer of uncoated papers sold under the Boise brand. The company operates eight mills and 94 corrugated product plants and shipped 55.7 billion feet of corrugated product last year.
Demand for corrugated product is rising roughly 4% per year due to e-commerce-based package deliveries and the company recently closed three bolt-on acquisitions that expand corrugated capacity. Packaging Corp. is also in the process of converting a production line manufacturing paper to corrugated product.
The benefits of higher production volume are evident in the company’s EPS, which grew 49% last year, marking the fourth straight year of EPS growth. Cash flow has consistently improved and expanded 14% annually over seven years. A better production mix and higher selling prices support analyst estimates for 32% EPS growth in 2018.
Packaging Corp. has raised dividends eight years in a row, including a 25% dividend hike last month. More dividend growth is likely due to modest payout at 34%.
D.A. Davidson analyst Steven Chercover upgraded his rating in February from “Hold” to “Buy,” and Stephens analyst Mark Connelly initiated coverage in November with a rating of “Overweight.”