Zacks Investment Ideas feature highlights: General Motors, Baxter
International, Church & Dwight, Microsoft and Wal-Mart Stores
CHICAGO, March 26, 2013
CHICAGO, March 26, 2013 /PRNewswire/ -- Today, Zacks Investment Ideas feature
highlights Features: General Motors (NYSE:GM), Baxter International
(NYSE:BAX), Church & Dwight Company (NYSE:CHD), Microsoft Corporation
(Nasdaq:MSFT) and Wal-Mart Stores (NYSE:WMT).
4 Stocks with Rapidly Growing Dividends
With interest rates stuck near record lows for the foreseeable future, more
and more investors are looking at dividend stocks for income.
But beware the siren call of high-yielding stocks.
A high single-digit or low double-digit yield may look attractive at first
glance, but yields that fat are rarely sustainable. Keep in mind that equity
investors take a back seat to bondholders and preferred stockholders in the
capital structure hierarchy. So that dividend check is no guarantee.
If times get tough and a company becomes strapped for cash, checks to
bondholders will get sent out before that dividend check. That's why it's not
uncommon to see high-yielding stocks slash or suspend their dividends during
economic slowdowns. One only needs to look at investors who picked up shares
of General Motors (NYSE:GM) or any of the "stable" bank stocks back in 2008
because of their alluring yields to realize that juicy dividends often don't
If you plan on holding onto a stock for a while, it's important to not only
look at its current yield, but consider its dividend growth potential too.
There are several metrics to consider when determining a company's dividend
One of the best measures is the payout ratio. The payout ratio is simply the
percentage of net income a company pays out to shareholders in dividends:
Dividends / Net Income
Even better - go to the company's statement of cash flows and look at the
percentage of dividends paid to its free cash flow, which is just cash from
operations less capital expenditures.
Knowing a company's dividend payout ratio is vital. Typically the higher the
payout ratio, the less room a company has to raise its dividend in the future.
And if a company becomes distressed, a high payout ratio can signal a
significant cut is on the way.
A company with a relatively low ratio of dividends to free cash flow, on the
other hand, may just have some big dividend hikes on the horizon. This is
typical of a younger, fast-growing company, assuming it even pays a dividend
at all. As the company grows and matures, however, it will have less growth
opportunities and will usually plow back less cash into the company and more
into your wallet.
That means a decent dividend yield today could become a huge yield in the
future. For instance, a company that raises its dividend an average of 12% per
year will double its dividend every 6 years. And at 18%, it will double every
Consider an example. Fictional XYZ Corp makes widgets. It trades for $50 per
share and currently pays a dividend of $1.25 for a yield of 2.5%. It earned
$3.75 per share this year, so its payout ratio is currently 33%. You decide to
buy some shares today.
Let's assume that over the next 10 years, XYZ sees its earnings growth slow
linearly from 15% per year to 7% per year. At the end of 10 years, it will be
earning $9.57 per share. Because of the slowing growth, the company decided to
increase its payout ratio each year too. By the end of year 10, the company is
paying out 67% of its earnings in the form of dividends. This equates to a
dividend of $6.38 per share, or a whopping 12.8% yield on your original cost!
This ignores any capital gains you might have, too.
Clearly, a company's dividend growth potential is very important for long-term
Sustainable Growth Rate
If a company is going to increase its dividend substantially over time,
however, it obviously needs to grow earnings and cash flow to do so. This is
why the sustainable growth rate of a firm is so important. The sustainable
growth rate is the maximum growth rate that a company can sustain without
having to issue more debt or more equity. It is calculated as:
(1 - Payout Ratio) x Return on Equity
For example, say a company pays out 30% of its earnings in dividends and its
ROE is 15%. Its sustainable growth rate would be 10.5% (.70 x .15). This is
approximately how much the company could grow its earnings using internally
generated cash. If the company wants to grow earnings faster than this, it
would need to take on more debt or issue more shares. Clearly the lower the
payout ratio and higher the ROE, the higher the sustainable growth rate. And a
higher sustainable growth rate means higher future cash flow growth and,
usually, higher future dividend growth.
This is another reason you should favor lower payout ratios when focusing on
long-term dividend growth. The more cash a company currently pays out to its
shareholders, the less it has to fund growth without either issuing more debt
or more equity. And that means lower long-term earnings growth, and smaller
future dividend increases too.
4 Stocks with High Dividend Growth Potential
So what are some stocks with strong long-term dividend growth potential? I
have listed 4 stocks below that I think are good candidates. Each have solid
current yields, a history of strong dividend increases, relatively low payout
ratios and high sustainable growth rates.
Baxter International (NYSE:BAX)
Current Dividend Yield: 2.5%
5-year Dividend Growth Rate: 15.6%
Trailing 12-month (TTM) Free Cash Flow (FCF) Payout Ratio: 41.3%
5-year Average Return on Equity (ROE): 30.5%
Sustainable Growth Rate: 17.9%
Church & Dwight Company (NYSE:CHD)
Current Dividend Yield: 1.8%
5-year Dividend Growth Rate: 47.6%
FCF Payout Ratio (TTM): 29.9%
5-year Average ROE: 16.3%
Sustainable Growth Rate: 11.4%
Microsoft Corporation (Nasdaq:MSFT)
Current Dividend Yield: 3.3%
5-year Dividend Growth Rate: 15.9%
FCF Payout Ratio (Trailing 6 Months): 30.8%
5-year Average ROE: 41.4%
Sustainable Growth Rate: 28.7%
Wal-Mart Stores (NYSE:WMT)
Current Dividend Yield: 2.5%
5-year Dividend Growth Rate: 14.6%
FCF Payout Ratio (TTM): 42.2%
5-year Average ROE: 22.2%
Sustainable Growth Rate: 12.8%
The Bottom Line
In this era of ultra-low interest rates, dividends stocks offer investors
attractive income potential. Just remember to be leery of those alluring
yields. If you have a long time horizon and plan to hold for years or even
decades, look beyond the current dividend yield and consider the dividend
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