Expect More Dividend Growth

8/11/2014


In the 12 months ended June, S&P 500 Index companies paid out nearly $333 billion in dividends, an all-time record and up 12% from the same period a year earlier. Similar trends are evident for the broader market, with U.S.-traded companies announcing 1,290 dividend hikes in the first half of the year, up 7% from 1,202 in the same period in 2013.

Worried that large-cap stocks can't support their recent dividend growth? Don't be. The big companies in the S&P 500 have a history of raising their payouts, if not quite as aggressively as we've seen recently. The index's dividends have risen at an annualized rate of nearly 7% over the last decade; FactSet projects S&P 500 dividend growth will slow to 7% in 2015, with the financial sector setting the pace as it continues to bounce back from the big cuts seen during the financial crisis.

Despite the S&P 500's three-year annualized dividend growth of 15%, dividends haven't gotten ahead of companies' ability to pay them. Payout ratios (the percentage of earnings or cash flow paid out in dividends) have been rising for three years and now sit near long-run averages. The index's expected year-ahead dividends represent a reasonable 36% of trailing 12-month earnings. For this story, we used a simplified version of cash flow, earnings excluding special items plus depreciation and amortization.

Some stocks, particularly the biggest banks, may keep growing their dividends at a rapid rate. However, the rest of the market will probably settle into a sustainable pace over the next year or two, with payouts well supported by profits and cash flows.

Dividends aren't the only way companies share their cash with investors. In the 25 quarters from the start of 2008 through the end of March 2014, S&P 500 companies spent more than $1.5 billion on dividends, eating up about one-third of operating profits. But if you factor in $2.2 billion in stock buybacks, the combined outlay accounted for 81% of profits.

The table below lists stocks with impressive dividend growth backed up by even stronger expansion of profits and cash flows. Three intriguing options are reviewed below.

During the first week of August every year from 2003 through 2013, industrial conglomerate Dover ($85; DOV) has raised its dividend, growing the per-share payout at an annualized rate of 10% during that period. Over those same 11 years, Dover grew its per-share profits at an annualized rate of 12% while cash flow rose at an 11% annual clip. With Dover's dividend accounting for less than 30% of earnings, the company enjoys plenty of flexibility to keep the payout rising. Despite the spin-off of Knowles ($30; KN) in February, which accounted for more than 10% of Dover's earnings, we expect the dividend to keep rising.

Last month, Dover raised its full-year profit guidance for 2014, and consensus targets for both 2014 and 2015 are on the rise. Analysts expect per-share profits to fall 9% this year, mostly because of the spin-off and unusual tax benefits realized in 2013. Excluding discontinued operations and the tax benefits, profits rose 12% in the first half of 2014. Dover, yielding 1.8%, is a Long-Term Buy.


Packaging Corp. of America ($66; PKG), commonly known as PCA, cut its per-share dividend to $0.60 in 2010 from $1.20 in 2008. Since 2010, the dividend has jumped to $1.60, with the last increase coming in the summer of 2013. While the company is likely to deploy some of its robust cash flow to keep paying off the debt it took on for its October 2013 acquisition of papermaker Boise, PCA should still have enough to boost the dividend. In the 12 months ended June, PCA's operating cash flow jumped 23% to $659 million (the shorthand cash flow we used for this story doubled to $796 million), more than enough to cover the $156 million it spent on dividends.

Over the last decade, PCA managed 32% annualized profit growth, more than triple its dividend-growth rate. While the company may not match last year's 28% dividend hike in coming years, growth of at least 10% a year seems like a safe bet. The consensus projects per-share-profit growth of 42% this year, 15% next year, and 19% annually over the next five years, so PCA can afford generous dividend increases. PCA, with a 2.4% yield, is a Buy and a Long-Term Buy.


Late last month, UGI ($48; UGI) raised its quarterly dividend 10% and announced a 3-for-2 stock split. The propane distributor and natural-gas utility has increased its dividend for 27 consecutive years, but recent activity has been unusual, with two increases in the last three months. The new quarterly dividend represents a 15% increase over the year-earlier payout.

Over the last decade, UGI managed annualized growth of 10% in per-share profits and 12% in cash flow, dwarfing the averages of 4% and 7%, respectively, for stocks in our Utility Update. UGI has set a long-term goal of 6% to 10% annual growth in per-share profits, enough to support continued dividend growth in line with the company's annual rate of 8% over the last decade. UGI, yielding 2.7%, is a Buy and a Long-Term Buy, as well as a component of our Top 15 Utilities portfolio.

STOCKS WITH SUSTAINABLE DIVIDEND GROWTH
The seven A-rated stocks below grew dividends at an annual rate of at least 4% over the last one and three years while boosting either profits and cash flow even more during those periods. This table uses simplified cash flow, earnings excluding special items plus depreciation and amortization. The payout ratio reflects expected year-ahead dividends as a percentage of trailing earnings or cash flow. Stocks recommended for purchase are presented in bold.
-- Payout Ratio --
12-Month Growth
------- Per Share -------
3-Year Annual. Growth
------- Per Share -------
10-Year Annual. Growth
------- Per Share -------
Company
(Price; Ticker)
Div.
($)
Yield
(%)
On
Earnings
(%)
On
Cash
Flow
(%)
Divs.
(%)
Profits
(%)
Cash
Flow
(%)
Divs.
(%)
Profits
(%)
Cash
Flow
(%)
Divs.
(%)
Profits
(%)
Cash
Flow
(%)
Sector
Dover ($85; DOV)
1.50
1.8
29
21
7
13
4
6
9
5
10
12
11
Industrials
Honeywell
($91; HON)
1.80
2.0
32
29
10
29
21
11
18
14
9
13
9
Industrials
Kellogg ($61; K)
1.96
3.2
33
30
7
105
67
4
19
14
7
10
6
Staples
Magna Int'l
($108; MGA)
1.52
1.4
20
13
19
36
11
15
17
15
8
9
9
Discretion.
Packaging Corp.
($66; PKG)
1.60
2.4
38
20
28
68
100
26
30
28
10
32
20
Materials
Time Warner
($85; TWX)
1.27
1.5
28
24
10
38
25
11
23
13
NM
8
0
Discretion.
UGI ($48; UGI)
1.31
2.7
44
21
15
25
11
8
7
14
9
10
12
Utilities
NM Not meaningful because dividends weren't paid a decade ago.

Everyone's getting involved

Nearly 85% of S&P 500 Index stocks pay a dividend, a level last seen in 1998.

Seven of the index's 10 sectors have at least 89% of their companies paying dividends. Even health care, the sector with the lowest participation, has 61% paying dividends. In every sector, dividend payers average yields of at least 1.6%, while seven sectors average yields of at least 2%. The average dividend payer in the S&P 500 yields 2.2%, while the average for all stocks — including nonpayers — is 1.9%.

In five of the 10 sectors, today's average yield lags the 10-year average. Fewer nonpayers (0% yield) make for a higher average yield, but the market's strong performance over the last few years has offset the effect of that rise in the number of dividend payers. If we exclude nonpayers, only two sectors top the 10-year average yield.

Nearly 85% of S&P 500 stocks pay dividends, up from just 70% in 2001 and 2002. However, in the early 1980s, more than 90% of S&P 500 companies paid dividends. It's tough to tell whether we'll reach that level again, but activity in recent years suggests the percentage is likely to rise modestly from current levels.

SECTOR BREAKDOWN
-------------- Average Dividend Yield --------------
------ All Stocks ------
--- Dividend Payers ---
Sector Index 10-Year Annual.
--------- Per-Share Growth ---------
S&P 500 Sector
No. Of
Dividend
Payers
% Of
Dividend
Payers
Current
(%)
15-Year
Average
(%)
Current
(%)
15-Year
Average
(%)
Dividends
(%)
Profits
(%)
Cash
Flow
(%)
Consumer Discretionary
64
76
1.5
1.5
2.0
2.0
13
8
9
Consumer Staples
38
95
2.4
2.4
2.5
2.6
11
7
7
Energy
40
89
1.9
1.2
2.1
1.4
10
10
12
Financials
79
95
2.2
2.4
2.3
2.6
(1)
(3)
(3)
Health Care
33
61
1.0
0.9
1.6
1.7
7
8
9
Industrials
61
95
1.8
1.9
1.8
2.0
8
8
7
Materials
29
97
1.8
2.0
1.8
2.1
7
8
6
Technology
45
68
1.4
0.8
2.0
1.7
22
14
15
Telecommunication Services
5
100
5.9
4.6
5.9
6.2
7
7
2
Utilities
30
100
3.8
3.8
3.8
4.1
6
4
5
S&P 500 Index
424
85
1.9
1.8
2.2
2.3
9
6
7

 


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