By David Sterman
After a volatile few months, interest rates appear to be settling back into a tight trading range. For example, the yield on the 10-year U.S. Treasury has hovered between 2.5% and 2.7% for more than a month now, after a stunning surge in May and early June that shook up the markets.
The relative quiet in the bond market gives investors a chance to pause and further assess their approach to dividend-paying stocks. Our take: It's not always the size of the dividend yield that counts, but the growth in the dividend as well. A stock with a stagnant 5% yield holds less long-term appeal than a 3% yielder that is poised for sustained long-term dividend growth. With that in mind, the current earnings season has given investors a fresh peek into the companies that sport moderate current yields but are capable of much higher yields down the road.
In fact, here's a quick look at companies that have recently reported quarterly results and appear positioned for sustained dividend growth.
1. AbbVie (NYSE:ABBV): Since January, AbbVie has delivered stellar quarterly results, highlighted by a recent fresh boost in profit guidance. Although the company will likely wait until year's end before boosting its current $1.60 a share dividend payout, current profit trends point to a 10% to 15% increase, as the company has a stated goal of parting with half of its cash flow in the form of a dividend. That may be why Standard & Poor's recently added AbbVie to its S&P 500 High Yield Dividend Aristocrats Index.
2. Helmerich & Payne (NYSE:HP): A decade ago, this provider of energy drilling equipment was content to issue 4% to 5% annual increases in its dividend. The payout got a bit more attention in recent years, as it rose roughly 12% annually in each of the past three fiscal years. Management is really stepping on the gas now, having recently hiked the quarterly dividend more than 200% to 50 cents a share. Commenting on just-released quarterly results, management noted that "we are confident that our strong capital structure allows us to pursue growth opportunities and, at the same time, return meaningful cash to shareholders." Translation: the current dividend, which now yields 3%, is set to move steadily higher.
3. Hasbro (NASDAQ:HAS): With the exception of 2008, when the dividend was held constant, this toy and games maker has boosted its annual dividend at least 20% in eight of the past nine years. That's one of the strongest dividend growth track records in the S&P 500. It looks like the streak may end this year, with the dividend rising just 11% to $1.60. The dividend growth would likely have been stronger, were it not for the fact that Hasbro is also buying back stock, with more than $50 million in share repurchases thus far this year. The current 3.4% dividend yield looks set for solid 10% annual increases in the years ahead, thanks in part to a current cost-cutting program that shake out some higher cash flow.
4. Wells Fargo (NYSE:WFC): There's a good reason why Warren Buffett has 20% of his firm's entire investment portfolio tied up in this banking giant. Wells Fargo sends him growing dividend checks every year. The payout stood at 20 cents a share in 2010, rose to 48 cents a share in 2011, 88 cents a share in 2012, and now stands at $1.20 a share, good for a 2.7% yield.
The current payout is still just shy of the record $1.30 annual dividend paid back in 2007. But brace yourself for much higher payouts in the future. Consider that Wells Fargo had never generated more than $24 billion in free cash flow in any year in its existence. But in 2012, that figure soared to $53 billion and is poised to rise higher still in 2013. Wells Fargo awaits more clarity on possibly stiffened capital requirements for banks, but once that matter is resolved, look for this dividend to steadily work its way to the $2 a share mark.
5. Baxter International (NYSE:BAX): This health care equipment provider's 7% dividend boost in 2011 must be seen as a disappointment. After all, the dividend rose by a 20% average annual clip in all other years going back to 2007. The 26% hike in the payout this year signals an ongoing commitment to dividend growth, meaning the current 2.7% dividend yield should steadily move higher in current years.
Here's a quick list of other solid dividend growers that have yet to report quarterly results. If history is any guide, their dividends may come in for more affection.
- Ensco (NYSE:ESV)
- Analog Devices (NASDAQ:ADI)
- Darden Restaurants (NYSE:DRI)
- Horace Mann Educators (NYSE:HMN)
- Molex (NASDAQ:MOLX)
Risks to Consider
Some of these firms are boosting their dividends even faster than cash flow is growing, which is leading to rising payout ratios. As a result, dividend growth will eventually have to slow to the rate of cash flow growth.
These companies aren't making random annual decisions about their dividends. The dividend policy is part of a long-term plan to return ever-increasing amounts of cash flow to shareholders. If the U.S. economy strengthens in the next few years, as many economists expect, then these companies look set to keep returning more cash to shareholders.