Dividend Growth On Fast Track
Companies in the S&P 500 Index paid a combined $311.77 billion in dividends in 2013, up 11% from 2012. That is below the three-year annualized growth of 15%, though that 15% is the best three-year rate in at least 25 years and reflects the restoration of some of the dividend cuts of 2009 and early 2010.
Will the robust growth continue? A look at historical precedents provides some clues.
Last year, the S&P 500 Index paid out an estimated 32.6% of its earnings in dividends. The current payout ratio (dividends as a percentage of earnings) is higher than that seen during most of the 2003 to 2007 bull market but lower than the average of 39% over the last 25 years and 44% over the last 50 years. Lower payout ratios reflect greater flexibility to boost dividends going forward.
Index dividends accounted for 22.8% of estimated cash flow (net income plus depreciation) last year, slightly above the 10-year average. Dividends have risen as a percentage of both earnings and cash flow over the last two years — no surprise, given the aggressive dividend hikes and modest operating momentum. The consensus projects per-share-profit growth of 11% for the index next year, a target many market watchers (including us) find overly optimistic.
The picture looks a little different when we consider dividends as a percentage of cash holdings. Last year, index companies paid out about 8.4% of their cash in dividends, below the 10-year average of 10.6%.
Higher dividends for the index don't just reflect a few massive payouts from the biggest companies; this is a marketwide phenomenon. In 2009, publicly traded companies announced 1,191 dividend increases or extra payments, versus 804 cuts or omissions. The number of positive dividend actions rose in each of the next four years, and in 2013 good announcements (2,895) outnumbered bad announcements (299) nearly 10-to-1.
What does all this mean? If S&P 500 dividends keep growing 15% annually, the index's dividends as a percentage of earnings and cash flow will rise above historical norms, a trend that seems unlikely given corporate executives' caution regarding cash deployment and the financial sector's newfound focus on strong balance sheets. That said, many companies have cash to spend and a commitment to raising the payout. In 2014, dividend growth of 9% to 15% seems likely. However, the index's dividend growth has averaged 6% annually since 1988, and growth seems likely to revert toward that long-run pace over the next few years.
Fifth Third Bancorp ($21; FITB) offers investors a blend of strong share-price action (up 38% in 2013) and a solid dividend yield of 2.3%, which exceeds its five-year average of 1.6% and the 1.8% average for regional banks in the S&P 500 Index. The stock also trades at just 12 times trailing earnings, a 10% discount to its peer-group average.
The quarterly dividend, currently $0.12 per share, has a long way to go before returning to its prerecession high of $0.44 per share. But it consumes just 28% of trailing earnings, and management seems eager to raise the payout in the year ahead if it gets the Federal Reserve's blessing. Current regulations prevent 30 large banks from paying dividends or buying back stock unless the Fed approves their capital-deployment proposals in March.
Stock buybacks shaved 6% from Fifth Third's share count in the past year — only five of the 81 financial stocks in the S&P 500 Index repurchased their stock more aggressively. Fifth Third, with scores above 60 for all six Quadrix categories and an Overall rank of 95, is a Buy and a Long-Term Buy.
Kroger ($39; KR) provides income-minded investors a play on a key component of higher dividend growth: steadily improving operating performance. Operating profit margins have risen in six straight quarters, while cash from operations increased in eight of the past 10 quarters and same-store sales climbed in 40 straight quarters. Last month, management reiterated its long-term profit-growth target of 8% to 11%.
The grocer still faces some challenges, particularly the November reduction in food stamps that has squeezed its least affluent shoppers. However, management believes that so far these shoppers have cut back in areas other than groceries. Eventually, Kroger's profit margins could compress as the company protects its market share by lowering prices. Nevertheless, the stock earns a Value rank of 89 despite its 55% total return in 2013, well ahead of the 33% average of S&P 500 consumer-staples stocks. Kroger, yielding 1.7%, is a Focus List Buy and a Long-Term Buy.
Magna International ($81; MGA), an auto-parts maker, cut and then temporarily suspended its dividend during the financial crisis. Since restoring the distribution in the June 2010 quarter, Magna has raised its payout five times, with three of those hikes coming in March quarters. The quarterly dividend stands at $0.32 per share, up 68% from its prerecession high. Stock buybacks have lowered Magna's share count by more than 6% since the end of 2010.
Both trends (dividend growth and share-count shrinkage) should continue, given Magna's recent operating momentum and sturdy balance sheet. Cash from operations rose 26% in the 12 months ended September, benefiting from 12% sales growth and steadily expanding profit margins. Free cash flow nearly tripled to $927 million over the 12-month period. The balance sheet holds $1.06 billion ($4.64 per share) in cash, compared to $96 million of long-term debt. Magna, yielding 1.6%, is a Focus List Buy and a Long-Term Buy.
Consensus estimates call for Schlumberger ($88; SLB), a leading provider of oilfield services, to report 23% higher per-share profits in the December quarter on 8% sales growth. Analyst estimates have fallen slightly in the past month as North America's land-drilling market suffered from softer activity in Canada and poor weather conditions in the U.S. However, Schlumberger has less exposure than its peers to North America, which accounts for roughly 30% of sales and operating income. Schlumberger is scheduled to report results Jan. 17.
Double-digit dividend hikes have accompanied Schlumberger's December-quarter profit report in each of the past three years, and the chances for another increase of 10% or more look good. Cash from operations surged 69% to $5.94 billion in the first nine months of 2013. Schlumberger, yielding 1.4%, is a Focus List Buy and a Long-Term Buy.
Wells Fargo ($45; WFC), like many other U.S. banks, has submitted its capital-allocation plan for 2014 to the Federal Reserve. Last March, Wells Fargo surprised investors by seeking — and winning — approval to raise its dividend 20%, which came on the heels of a 14% hike announced in January 2013. Wells Fargo's indicated year-ahead dividend equates to just 32% of trailing earnings, below its sector's average payout ratio of 40%. The stock yields 2.6%, exceeding its five-year average of 2.2%.
Although the mortgage business has slumped in recent quarters, healthy loan growth and deposit inflows help to support Wells Fargo's operating momentum. The consensus projects 4% higher per-share profits on a 1% revenue gain in 2014. Shares trade at just 12 times estimated year-ahead earnings, a 36% discount to the sector median. Wells Fargo, scoring above 90 for both sector-specific ranks, is a Focus List Buy and a Long-Term Buy.