Dividend Investing Golden Rule #1: Look out for Strong Dividend Growth Stocks
I have written about Dividend investing several times and came out with the Ultimate Guide to Dividend Investing which I believe is very useful for someone looking to start his/her dividend investing journey.
In this article, I will be exploring one of the most important Golden Rule when it comes to dividend investing, specifically Golden Rule #1 – Growth Rule: Invest in stocks with track records of dividend growth.
Firms increasing their dividends in 2020 are sending a powerful pay-out message to Wall Street. In-spite of COVID-19, their dividends are secure. So secure that they are not just looking to maintain their dividend amount but hiking it. Watch our stock price follow!
The bigger the increase, the greater the level of confidence. In a while, we will be exploring four of these companies which have signaled “confidence” in their companies’ prospects by hiking their dividends significantly in 1H20, a period that saw many companies’ operations ravaged by COVID-19.
Why are dividend hikes worth watching? That is because investors tend to chase dividends higher over time as a proxy of earnings growth.
Assuming that the payout ratio of a firm (dividend payment/earnings) remains relatively constant, a higher dividend payment suggests that earnings are growing in tandem, and the higher that dividend growth is, the stronger is the “implication” that future earnings growth are going to be equally robust.
That is why dividend stocks that generate a strong dividend growth profile tend to see out-performance (relative to the index performance) in their share prices as well.
Based on screening from Stock Rover, there are currently 55 companies in the US which met the following dividend criteria:
- Dividend 1-Year Change (%) > 15%
- Dividend 3-Year Change (%) > 10%
- Dividend 5-Year Change (%) > 5%
- Dividend Yield (%) < 1.5%
Fast-growing but low yield?
Note Criterion 4. I am in fact screening for dividend stocks that do not pay a high dividend yield, taking into consideration the 30% dividend withholding tax which will “hurt” a foreign investor.
I have written about dividend withholding tax in one of my latest articles titled: UCITS ETFs taxation. Are they that cost-efficient after-all?
In that article, I highlighted the issue of Dividend withholding tax for a foreign, non-US investor looking to partake in dividend investing. The 30% Dividend Withholding Tax rate tends to increase the “hidden indirect” cost of investing in dividend stocks.
The higher the yield of a particular US stock or ETF, the greater will be that indirect cost.
Hence, for a dividend investor looking to partake in US stocks/ETFs, the focus should not be on how high that particular counter’s yield is but how fast that counter is increasing its yield. For ETFs, because they consist of a basket of dividend stocks, it is highly unlikely that their dividends are growing at a double-digit rate.
There are many individual stocks on the other hand that exhibit this profile.
Again, for a foreign investor, we want to be “looking” for low yield stocks which are growing at a double-digit rate every year. This reduces our indirect cost associated with the high dividend withholding tax rate while concurrently giving us exposure to fast-growing dividend counters that might also imply strong forward price appreciation.
Note that we only want to find stocks which show consistency in their dividend growth profile and not a “one-hit” wonder, the latter referring to a stock which grew its dividend strongly over the past 1-year but its dividend growth profile has been rather inconsistent when we extrapolate back over the past 5-years.
Hence, our screening criteria which take into account the dividend growth strength of a company over the past 5-years. In fact, out of the 55 companies, we are only focusing on 4 companies which have demonstrated dividend growth consecutively over the past 9 years.
These are the “best of the best” dividend growth companies which are yielding below 1.5% (lower our indirect cost associated with dividend withholding tax) that might be suitable for a non-US investor looking to partake in dividend growth investing through taking a stake in individual companies.
Strong Dividend Growth Stock #1: Visa (V)
Visa is one of the best dividend growth stocks within the US dividend universe, with the counter growing its dividend per share (DPS) from $0.13 back in 2010 to the current level of $1.05 in 2019 or a CAGR of 23%. Based on the current project, its DPS is expected to be $1.20 in 2020 or a 14% growth rate this year.
Not too shabby considering that Visa’s operating climate has been significantly impacted, first by the global shutdown in economic activities, and second, which the company is still reeling from, which is the halt in global air travel activities that have significantly curtailed tourism spending, most of which using its credit cards.
Nonetheless, the company has maintained its DPS at $0.30/share over the past 3 quarters and is likely to end its financial year with a DPS of $1.20/share according to consensus estimates.
If so, this will mark its 12th consecutive year of dividend growth.
The market believes that Visa will likely be able to continue growing its dividend profile, taking into consideration its low payout ratio of just c.20% which gives the company huge leeway in growing its dividend payment in-spite of temporary operational hiccups, as seen in 2020.
On its valuation, using the dividend yield theory as a basis, Visa remains overvalued however, with its past 10-years average dividend yield at 0.75% vs. its current yield level of 0.60%.
This is the TradersGPS weekly chart of VISA. This is clearly a stock which you won’t want to short. It has made a good recovery through the market crash in March and is now at pre-CoVid levels again.
Strong Dividend Growth Stock #2: S&P Global (SPGI)
SPGI is an American publicly traded corporation. Its primary areas of business are financial information and analytics and are the parent company of S&P Global Ratings, S&P Global Market Intelligence, and S&P Global Platts, CRISIL, and is the majority owner of the S&P Dow Jones Indices joint venture.
The company has been growing its DPS from $0.94 in 2010 to $2.28 in 2019 or a CAGR of 9% over the past 10 years. Expectations are high for the company to increase its DPS from $2.28 in 2019 to $2.68 in 2020, an annual growth of 17.5%. The company has already issued a DPS payout of $0.67/quarter (vs. $0.57 a year ago) over the past 2 quarters which demonstrated the confidence of its operations. SPGI is a company that has increased its dividend for at least 46 consecutive years thus far.
While companies saw their operations being battered as a result of COVID-19, SPGI grew its earnings strongly in 1H20 by 52% YoY. As a result, the company is more than comfortable to raise its DPS by 17.5%, with a payout ratio of just 23%.
The street has an average TP of $391/share for the counter, implying that the stock still has a 16% upside from its current share price level.
Based on the dividend yield theory, the counter is “overvalued” with an average 10-year yield of 1.5% vs. the current yield level of 0.8%.
This is the TradersGPS daily chart of SPGI. As you can see, this is generally a nicely moving stock, good for trading. The TradersGPS system picked up on the March drop, keeping bulls out of this market and even giving the bears a good opportunity to get onto the move down. Right after that, the system caught the recovery move of over 25%.
Strong Dividend Growth Stock #3: Sherwin-Williams (SHW)
SHW is the 3rd dividend growth stock in our list, with the counter growing its DPS from $1.44 back in 2010 to $4.52 in 2019 or a CAGR of 12% over the past 10 years. The counter grew its DPS in the past 2 quarters by $0.21, implying a growth rate of 18.6%. If maintained, this implied a DPS of $5.36 in 2020, up from $4.52 in 2019.
SHW primarily engages in the manufacture, distribution, and sale of paints, coatings, floorcoverings, and related products to professional, industrial, commercial, and retail customers primarily in North and South America and Europe.
Despite COVID-19, SHW has been able to grow its profits in 1H20, from $715m in 1H19 to $914m in 1H20 or a growth of 28%, which demonstrated its operational resilience. Hence its DPS growth of 18.6% is likely to be comfortably covered, assuming that 1H20 sees similar earnings growth.
According to the street’s estimate, SHW is expected to grow its EPS by 40% this year, tapering to a more moderate 9% in 2021.
With a payout ratio of just 26%, SHW dividend payments are well-covered. The company has grown its dividend for 41 consecutive years and this year should make it 42.
Based on a 10-year average dividend yield of 1.1%, the company is slightly overvalued from a dividend yield theory perspective, with its current yield being at 0.8%.
This is the TradersGPS daily chart of SHW. Once again the TradersGPS system picks up on the recovery move that’s over 25% as well.
Strong Dividend Growth Stock #4: Anthem
Anthem is one of the largest private health insurance organizations nationwide, providing medical benefits to roughly 42 million medical members. The company offers an employer, individual, and government-sponsored coverage plans.
Anthem differs from its peers in its unique position as the largest single provider of Blue Cross Blue Shield branded coverage, operating as the licensee for the Blue Cross Blue Shield Association in 14 states. Through acquisitions, such as the Amerigroup deal in 2012, Anthem’s reach expands beyond those states through government-sponsored programs such as Medicaid, too.
The Company started paying dividends only from 2011 onwards but has since grown its DPS from $1 to the current level of $3.20 in 2019. According to its 1H20 DPS of $0.95/quarter, the company is on track to pay a full year DPS of $3.80 in 2020, representing a growth rate of 18.75%.
This is supported by not just a low payout ratio of just 15% but also the fact that Anthem is one of the few companies that demonstrated consistent earnings growth over the past decade. In 1H20, the company grew its EPS by 45%. The street is expected full-year EPS growth to be in the region of 22%.
With an average 9-year historical yield of 1.5%, the counter is again “overvalued” based on the Dividend Yield Theory, with its current yield at 1.2%.
This is the TradersGPS weekly chart of ANTM. This stock has been in a sideways market since late 2018 and last week we’re seeing a strong move above the 310 area of resistance, looks like ANTM could be ready for its next major move. The system identified this stock since early October and is still in.
These 4 stocks represent some of the strongest dividend growth counters. Except for Visa, the other 3 stocks in this list continue to grow its EPS in 1H20 despite COVID-19 and this has helped to support their dividend growth profile.
All 4 companies have a very low payout ratio which gives comfort that their dividend growth payment can still be maintained even amid short-term operational hiccups.
The key risk remains on valuation. Against a declining interest rate environment, we have seen these stocks benefiting from a “valuation expansion” from the point of a declining yield angle. If the belief is that interest rates will remain at a low level for a “prolong” period, it is thus reasonable to believe that these strong dividend growth stocks can remain “low yielding” for the foreseeable future.
However, if their yield reverts to their 10-year historical average, these stocks might see a substantial price “de-rating” in-spite of their strong dividend growth profile.
Nonetheless, for foreign dividend investors like us here in sunny Singapore, investing in strong dividend growth companies should be the preferred strategy over searching for high dividend yield counters, especially when you account for the indirect cost as mentioned earlier.
While the returns on a yield basis might not be attractive, it is demonstrated that total shareholder returns (dividend yield + capital appreciation) over the past decade for this category of stocks has trumped that of high yield counters.
If you enjoyed reading this article and various other investment + personal finance articles, do visit New Academy of Finance. Royston has more than 10 years of buy and sell side experience as a financial analyst. He constantly posts interesting, valuable and actionable articles.
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