By Serkan Unal
Cash-rich companies operating in an environment constrained by limited growth opportunities and low yields on investments are returning the ever-increasing amounts of cash to their shareholders. Thus, dividends are growing at a robust pace. The S&P 500 Index's annual dividend growth in 2011 topped 10.0%, which was double the average rate since 1950 and triple the rate since 2000, according to T. Rowe Price. The asset manager concludes that over the past 33 years, dividend growers in the Russell 1000 Index "outperformed dividend-paying stocks, the index itself, non-dividend-paying stocks, and stocks that cut their dividends."
In line with this conclusion, we focus on five dividend growth stocks that are likely to perform well in the next five years. These stocks are components of the Gabelli Dividend Growth Fund (GABBX), which seeks capital growth through investments in the stocks of high-quality companies with sustainable dividend growth and rising profitability. The following five stocks are ranked in the fund's top 10 holdings. These stocks were selected based on the indicators such as management's commitment to increasing shareholder value through dividend increases, strong capital position, accelerated dividend growth, industry expansion, and above-average EPS growth that point to the companies' capacity to continue boosting dividends in the future. Each pick pays a dividend yield higher than the average on the S&P 500 Index of 2.2%.
International Paper Inc. (NYSE:IP) is a market leader in paper and packaging. It pays a dividend yield of 3.0% on a payout ratio of 61%. Even though its dividend grew, on average, by only 1.7% annually over the past five years, the company boosted its dividend by a much-higher 14% in October 2012. International Paper had indicated earlier it could hike its dividend by 50% over the next two-to-three years. Buoyed by the strong demand for its products from surging online sales at places like Amazon.com (NASDAQ:AMZN), the company is expected to see its EPS surge by 40% next year. For the next five years, the company's CAGR is forecast at about 5.6%. IP has a free cash flow yield of 5.8%. It is priced attractively with a forward P/E of 12.6x, well below the broader market and almost on par with its respective industry. Value investor Jean-Marie Eveillard's First Eagle Investment purchased a stake in the company last quarter.
General Electric Co. (NYSE:GE) is an industrial conglomerate with a dividend yield of 3.6% and a payout ratio of 60% of trailing earnings and 39% of free cash flow. While its dividend was slashed in 2009, it has since recovered by 90%. The latest 11.8% dividend hike took place this month, along with a share buyback authorization worth $10 billion. The company's CEO recently stated that "returning cash to shareholders remains a top priority." As the global economies return to growth in the next five years, GE's EPS CAGR will average 11.2% over that period. The company's growth will be driven, at least in part, by a robust healthcare sector growth, market share expansion in aviation, and strong capital position with ample funds available for mergers and acquisitions and share repurchases. GE has a free cash flow yield of 3.7%. It is priced at 12.9x its forward earnings, slightly below its respective industry. It is a value stock, given its below-industry price-to-book and price-to-cash flow, and above-industry dividend yield. Billionaire Ken Fisher is especially bullish about GE.
Exxon Mobil Corporation (NYSE:XOM) is the oil and gas behemoth with a dividend yield of 2.6% and a payout ratio of 24%. The company's dividend growth averaged 9.7% per year over the past five years. This year, Exxon Mobil raised its dividend by a much higher 21%, making it the largest dividend payer in the world. The company's 5-year EPS CAGR is forecast at 6.3%, which is faster than the growth rates of its competitors. Given its low payout ratio and robust cash flow generation, the company is likely to sustain dividend hikes in the future. The continued shale gas and oil boom and a rebound in natural gas prices to which Exxon Mobil is more leveraged than its peers will help the company grow its top and bottom lines. The company has negligible long-term debt relative to equity and a free cash flow yield of 2.8%. The stock is trading at 11.2x its forward earnings, above 9.4x of its industry. Exxon Mobil is popular with billionaire Stanley Druckenmiller (check out his major holdings).
Enterprise Product Partners LP (NYSE:EPD) is a midstream services company for the oil and gas industry. It pays a distribution yield of 5.1% with healthy distribution coverage of 1.3x. The MLP's distributions grew, on average, by 5.8% annually over the past five years. The latest above-average distribution hike of 6.1%, year-over-year, marks the MLP's 33rd consecutive quarterly hike. The company has greatly benefited from the shale gas and oil boom, which has boosted the oil and natural gas pipeline volumes to a record. With nearly $8 billion worth of projects coming into service by 2015, this MLP's capacity expansion will help improve sales and earnings. The MLP's 5-year EPS CAGR is forecast at 7.4%. The partnership is undervalued based on the trailing P/E of 18.5x versus 28.9x for its industry. Its forward P/E is almost on par with its peer group. RenTech's Jim Simons boosted his stake in this partnership by nearly 120% in the previous quarter.
BlackRock Inc. (NYSE:BLK) is the world's biggest asset manager. It dividend is yielding 2.9% on a payout ratio of 46%. The company generates large free cash flows, and is able to afford meaningful dividend increases. It has been a major dividend grower over the past five years, hiking its dividend, on average, by 17.5% annually. The company's dividend has increased six fold over the past eight years. BlackRock recently reported revenues and EPS above analyst expectations based on strong sales growth and AUM expansion. The asset manager's 5-year EPS CAGR is forecast at 12.5%. The stock has a free cash flow yield of 4.4%. On a trailing P/E basis, the shares are undervalued compared to the company's peer group. The asset manager has a price-to-book below that of its industry and its own 5-year average. Fund manager Jonathon Jacobson (Highfields Capital-check out its top picks) is the top hedge fund investor in this stock.