Surprising Sector: Tomorrow's Dividend Growers

by: YCharts

By Carla Fried

For the first time since the onset of the financial crisis, stocks that don't pay dividends, led by the likes of Google (NASDAQ:GOOG) and Netflix (NASDAQ:NFLX), gained more in the past 12 months than dividend payers, according to FactSet (NYSE:FDS). That's what happens when dividend payers start looking pricey even to the true believers and the allure of defensive income stocks wanes amid continued signs of economic strengthening.

Moreover, the growth rate for dividends is beginning to decelerate. After a 15% rise for the trailing 12 months -- fueled in part by special dividends paid out late last year ahead of feared tax changes -- FactSet says analyst estimates are for S&P 500 dividend payers to increase their payouts by 9.7% over the next 12 months.

A 10% rise in dividends is still very, very strong. And it turns out that the S&P 500's average payout ratio is now above its 10-year median. Granted, at 31.5%, we're not talking nosebleed level. But the rising payout ratio -- up 1.5 percentage points over the past year -- highlights an important nuance in the markets: many companies are aggressively raising their dividend to appeal to income/defensive investors at a rate that exceeds their earnings growth. That's not necessarily a problem. If the payout ratio is below 40% or so, there's still plenty of room to keep up a compelling pace of dividend growth. But when you've got payout ratios north of 60% it becomes harder to keep up an impressive rate of future dividend growth without beginning to cannibalize other claims on your money, be it capital expenditures, R&D or M&A.

The $10.4 billion Exxon Mobil (NYSE:XOM) paid out in dividends over the past 12 months was the highest in pure dollar terms. Despite growing capital expenditure needs and industry-wide concerns about reserve replacement, Exxon Mobil's below-25% payout ratio suggests it won't soon be pressured to slow down on the dividend growth. Over the past five years Exxon Mobil's payout has grown nearly 60%.

Same story with Apple (NASDAQ:AAPL), which is already in the top 10 of dividend payers in dollar terms, though it just resumed shelling out a dividend last year. Its sub-20% payout ratio is insanely low. The only caveat is that cash held overseas can't be used to pay U.S. dividends. Still, Apple has made it clear it intends to keep the dividend growth pipeline flowing; with plans to pay out as much as $100 billion by the end of 2015 in combined buybacks ($60 billion) and dividends ($40 billion). The current annual dividend payout is about $11 billion. So if Apple spends the full $40 billion over next 2.5 years that implies a significant increase.

You can't say that for all big dividend payers. This chart shows the current payout ratios for Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG) and General Electric (NYSE:GE), all of which are in the top 10 in terms of dollars spent on dividends:

JNJ Payout Ratio TTM Chart
(Click to enlarge)

JNJ Payout Ratio TTM data by YCharts

A common thread for all three is using dividend hikes to mollify/distract shareholders from missteps. Johnson & Johnson has been aggressive in that regard. Over the past three years as it dealt with recalls, lawsuits and the need for management changes, the company raised its dividend by 22%, even though earnings per share fell more than 24%. That's um, not sustainable over the long term. Either J&J can sprout more earnings or it eventually might need to slow the pace of dividend growth; that would make it a far less appealing dividend stock to own. A quick look on the YCharts Stock Screener of the other major drug manufacturers in the S&P 500, turns up Pfizer (NYSE:PFE) as the only company that managed positive earnings growth over the past three years and still has a sub-50 payout ratio.

That said, Pfizer's lowish payout ratios is thanks to a massive 50% dividend cut in 2009.

For a far better mix of competitive yields, far better dividend growth prospects and more compelling valuations you really should be spending more time trawling through the technology sector, and you can easily do that on the YCharts Stock Screener, a handy investment analytics tool.

Analysts surveyed by FactSet expects dividend growth among S&P 500 tech dividend payers to average more than 30% over the next 12 months. Moreover, this sector is where everyone else isn't. While dividend-focused mutual funds and ETFs have seen strong inflows since the end of the recession, most portfolios impose a time-requirement of 10 or more years of dividend history for a stock to be eligible for a portfolio. That rules out plenty of tech stocks, which have only been paying out dividends for a few years.

The new WisdomTree U.S. Dividend Growth ETF (NASDAQ:DGRW) skips the longevity requirement. The portfolio currently has 20% invested in dividend-paying tech stocks; its single-sector limit. Apple, Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) are among the ETF's top 10 holdings. Payout ratios in the low 40s for both Microsoft and Intel are far higher than Apple. Still, Microsoft managed to double its dividend over the past five years and Intel raised its dividend by 60%.

Cisco (NASDAQ:CSCO) and Qualcomm (NASDAQ:QCOM) are also in the WisdomTree portfolio, and have payout ratios below 30%. Cisco has nearly tripled its payout in the two years since it started a dividend program. Qualcomm more than doubled its dividend over the past five years. While Qualcomm's EBITDA nearly tripled from its 2009 lows, the company's valuation hasn't budged.

QCOM PE Ratio TTM Chart
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QCOM P/E Ratio TTM data by YCharts

That from a stock with a 2.3 % yield and plenty of earnings to keep the dividend growth coming.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.