Buy Dividend Growth For More Than The Dividends
Dividend growth matters, and not just because it increases the income a stock generates.
When companies grow dividends, they tend to signal they're generating strong cash flow, committed to sharing that cash with stockholders, or confident in the future prospects of their business. Oftentimes, dividend hikes make all three points.Â
Our research suggests rising dividends may also signal something else — superior stock returns.
Since the end of 1994, the top quintile (one-fifth) of the S&P 1500 Index as measured by trailing three-year dividend growth had an average 12-month return of 14.1% and a median return of 11.2% — above the returns of the broad index, as shown in the chart below. Top five-year dividend growers also outperformed, though not by as much as three-year leaders.
Since the end of 1994, it has taken an average of 15% annualized dividend growth over the previous three years and 14% over the last five to qualify for the top quintile. Today it requires respective growth rates of 26% and 22% to qualify. All of the A-rated stocks in the table below have posted double-digit dividend growth. Three are discussed below:
ADT ($38; ADT) initiated its quarterly dividend in November 2012. Since then, the home-security provider has boosted the payout twice, most recently in January, and the quarterly dividend has risen 68%. With only 10 quarterly dividends on the books, ADT has less history than any of the other stocks in the table on page 5. But given its strong cash flow — per-share cash from operations jumped more than 18% last year — ADT seems likely to continue boosting the dividend, as well as buying back shares. The share count fell 12% last year and 9% annualized over the last three years.
Consensus per-share-profit targets project growth of 4% this year and 6% next year. Estimates have risen over the last three months but may still be too low. ADT is a Focus List Buy and a Long-Term Buy.
CVS Health ($101; CVS) has raised its quarterly dividend in each of the last 12 years, most recently by 27% in December 2014 and 22% in December 2013. The company targets a payout ratio of 35% by 2018; the current indicated year-ahead dividend equates to 31% of 2014 earnings. Operating cash flow rose 41% last year and 12% annualized over the last three, a trend that should support continued dividend increases.
Both of the company's businesses — retail drugstore and pharmacy-benefit manager — seem poised to benefit from a broad-based rise in drug usage, particularly generics and specialty medications. Consumers' and insurers' increased focus on medical outcomes also favors CVS, which differentiates itself from rivals through personal interaction with customers. The company says its efforts to encourage consumers to take their medications and monitor their conditions can lower medical costs. CVS, which was slated to announce March-quarter results May 1, is a Buy and a Long-Term Buy.
After boosting capacity just 2.4% in 2014, Southwest Airlines ($41; LUV) increased available seat miles 6% in the March quarter, with plans to grow 7% for the year, much of that via new flights at its Dallas hub. Despite the higher capacity, load factor (revenue passenger miles as a percentage of available seat miles) rose to a record 80.1% from 79.3% a year earlier. Booking remained strong in April.
In the quarter, Southwest earned $0.66 per share excluding special items, topping the consensus by $0.01 and up from $0.18 in the same quarter a year ago. Revenue rose 6%. A 33% decline in fuel and oil expense offset double-digit increases in salary and depreciation expense, and operating profit margins more than tripled.
Since holding its dividend steady from 2001 through 2011, Southwest has given the payout some lift, raising it each of the last three years. Given that the last three hikes occurred in mid-May, Southwest seems due for some good dividend news. The stock is a Long-Term Buy.Â
Yield doesn't always mean value
Our preference for high dividend growth over high yield is well known to regular readers. Dividend yield is a component of the Quadrix Value score, and while it doesn't do well at predicting outperformance, yield has long been associated with value.
Today we compare stocks in both camps to see whether high-yield stocks are in fact better values.
We found that both yield and dividend-growth leaders earn roughly similar Quadrix Value scores and trailing price/earnings ratios. Dividend-growth leaders tend to trade at greater premiums to five-year average valuations, but also look cheaper relative to estimated earnings and growth rates.
Of more import was the Quadrix Overall score. The top quintile (one-fifth) of the S&P 1500 Index based on yield averaged an Overall score of 50. In contrast, the top quintiles based on three-year and five-year dividend growth earned Overall scores of 67 and 62, respectively.