Looking For Tomorrow's Dividends
In good times or bad, dividend increases make a difference. A history of dividend increases suggests a company possesses financial fortitude and a commitment to sharing the wealth with stockholders. Over the long haul, dividends can contribute significantly to total return — and help mitigate losses during tumultuous markets.Â
Aggressive cost-cutting in recent years, combined with healthy increases in sales and earnings, allowed many companies to build up huge piles of cash. Dividend hikes are a crowd-pleasing way for companies to deploy this cash. And deploy they have. As of Oct. 31, 265 companies in the S&P 500 index had raised their dividend so far this year — a 39% increase from the same period a year earlier.
Admittedly, dividend growers are not difficult to find. But it can be a challenge to unearth income plays positioned for steady profit growth, and that also boast solid QuadrixÂ® scores and tend to maintain a modest payout ratio (implying the potential for more dividend hikes).
We listed 13 such standouts in the table below. For each stock, we calculated three years of estimated per-share dividends based on recent dividend payments, trailing 12-month dividend payout ratios, and projected per-share earnings. All 13 have shown steady dividend increases, with three-year annualized growth rates of at least 9%. All 13 are also expected to grow per-share earnings this year and in each of the next two years. We review four of these standouts in the following paragraphs.
Abbott Laboratories ($54; ABT) has increased its quarterly dividend in 39 consecutive years. In the past three years, the dividend has grown at an annualized rate of 10%, topping the other big U.S. drug companies. The stock, up 12% this year, offers a 3.5% yield, exceeding its five-year average of 3.0%.
The dividend, however, will undergo a shift from its present form next year when Abbott splits its pharmaceutical unit ($18 billion in sales) from the rest of its businesses ($20 billion). Both companies will pay a dividend, and taken together, their distributions should equal Abbott's dividend at the time of the separation. Backstopped by strong balance sheets, both new companies should also receive investment-grade credit ratings, Abbott says. Some speculate that the new pharmaceutical company could receive a heftier portion of debt and cash, since the medical-devices business will likely be better equipped to generate free cash flow. Abbott Labs is a Long-Term Buy.
Dover ($56; DOV), an industrial conglomerate, makes everything from hydraulic lifts to refrigeration systems to hearing-aid components. Order activity remained strong in the opening weeks of the December quarter, management says, building on the 20% increase in bookings during the September quarter. Dover anticipates revenue will climb 20% in 2011, bolstered by at least 8% organic growth in all four segments. Free cash flow is on pace to represent 10% to 11% of revenue for the year. That implies a record $856 million to $941 million in free cash flow, marking the strongest growth since 2003.
That cash will likely fund Dover's steady stream of dividend hikes and acquisitions. Dover announced a 15% dividend increase in August, marking its 56th consecutive year of dividend growth. Dover has also purchased at least eight companies so far this year, spending more than $1.37 billion. In its latest deal, completed in November, Dover acquired Advansor A/S of Denmark to expand its presence in the refrigeration-equipment market. Dover is a Long-Term Buy.
IBM ($187; IBM) uses a two-pronged approach for sharing profits with stockholders. The dividend has grown for 16 straight years, including a 15% hike in May. The tech giant has raised its payout at an annualized rate of 26% over the last five years, well above its growth rate for per-share profits (17%) and operating cash flow (5%). IBM also has a seemingly insatiable appetite for its own stock, buying back enough to lower the share count 5% over the last year and 21% over the last five years.
Looking ahead, IBM seems capable of returning even more cash to shareholders. Despite the steady dividend growth, IBM's payout ratio is a modest 23% of trailing earnings. Management expects $100 billion in free cash flow over the next five years, translating to 12% growth from the previous five years. Roughly 70% of that cash should return to shareholders through dividends and buybacks. IBM is a Buy and a Long-Term Buy.
Microsoft ($27; MSFT) raised its dividend 25% in September, nearly double its five-year annual growth rate. The dividend hike pushed Microsoft's yield to 2.9%, well above the 2.0% average for dividend-paying technology stocks in the S&P 500 Index. The company has $11.2 billion remaining from a $40 billion share-repurchase program launched in 2008. That balance is enough to buy back about 5% of outstanding shares at current prices. In the past year, Microsoft has spent $5.4 billion in dividends and $8.5 billion on repurchases.
Yet Microsoft's massive cash hoard still gives it plenty of flexibility. The software giant generated $19.66 billion in free cash flow in the 12 months ended September. It now holds $57.40 billion in cash and short-term investments — though roughly 90% is offshore — versus long-term debt of $11.92 billion. Net cash equals $5.36 per share, roughly 20% of the stock price. Microsoft is a Buy and a Long-Term Buy.