Some large-cap companies that are exciting for income investors to own are what I like to call "the rocket ship dividend companies" because they are doing two things simultaneously: (1) increasing their dividend payout ratio, and (2) increasing their earnings per share at a clip greater than 8%. It's a great recipe for achieving significantly high future yields-on-costs for investments that you make today.
When researching for these kinds of companies, one company worthy of full diligence is MasterCard (NYSE:MA).
For most of its trading history, MasterCard had no pretense of appeal for income investors. There was no dividend until 2006, and the dividend received in 2006 was only a penny (adjusting for the recent ten-for-one stock split). Then, the annual dividend remained static at the $0.06 mark until the end of 2011.
But somewhere during the past couple of years, MasterCard began showing signs of taking its dividend payout to shareholders more seriously. The quarterly dividend doubled from $0.015 to $0.03 in the second quarter of 2012, then doubled again to $0.06 in the second quarter of 2013. Shareholders in 2014 were welcomed with yet another significant dividend increase, as the $0.06 quarterly dividend grew to $0.11 per share.
Although the 30.5% dividend growth rate of the past five years is almost entirely the product of MasterCard's picayune dividend payout, the story of rapid dividend growth does not seem to be over yet: in relation to expected 2014 earnings of $3.10 per share, the current $0.44 quarterly payout still only amounts to 14% of current profits. Rather than doing something like pay out $1.50 in cash right now, the MasterCard Board seems to be employing the "sliding approach" of rapid dividend increases spread out over a decade or more (for comparison, see the change in McDonald's (NYSE:MCD) dividend payout from 2000 to 2013, as the payout ratio increased from the 15-20% range to the 50% range).
But the appeal of MasterCard is not just the potential rise in the dividend payout ratio: the company is also increasing earnings per share quite rapidly. Every core metric for the company appears on solid footing right now: in the past two years, MasterCard has doubled its cash on hand from $2 billion to slightly over $4 billion. Revenues have been increasing at 14% annually because its MasterCard, Maestro, Cirrus, and MasterCard Electronic brands operate on the gross dollar volume model which means that increases in card spending is an automatic inflation hedge that automatically trickles to the company's bottom-line without the requirement of additional investment.
In fact, MasterCard's reinvestment needs have declined in recent years as the company has been processing ever larger volume amounts without needing to set aside more capital for development of its credit infrastructure. To put numbers on it, you can see that operating margins have increased from 38.4% in 2008 to 47.0% at the end of 2013. This is what happens when your company benefits from people spending more money on cards but the cost of maintaining the infrastructure does not rise commensurately.
But even though revenues are increasing at a 14% annual clip, the profits per share have actually been raising by a higher clip because MasterCard has a serious commitment to reducing share count through stock buybacks. At the time MasterCard started its buyback program in 2005, there were 1.35 billion shares outstanding. Now, that figure is down to 1.16 billion. In other words, only 85% of the shares exist today that did exist in 2005 (and some of this understates the true effect of MasterCard's buyback program, as it has issued stock for minor acquisitions in recent years that allowed shareholders to benefit from having new companies under the MasterCard corporate umbrella without having to experience overall share count dilution). The net effect for MasterCard in the past two years has been this: core profits have been increasing by 14% annually, but due to the additional effect of stock buybacks, profits per share have been increasing by 17-18%.
The best hockey player of all time, Wayne Gretzky, once gave hockey advice that applies well to investing: "I skate to where the puck will be, not where it is." In the case of MasterCard, we have a very interesting opportunity in front us for dividend investors that are willing to accept a low payout now (the current dividend yield is still only 0.5%, thus putting it automatically off the radar of many investors interested in income who could get almost 4x the starting yield by merely investing in an index fund that tracks the S&P 500).
The appeal of MasterCard is where its dividend will be ten years from now. You have a situation where a lot of positive forces are coming together: core profits are growing by double-digits, the growth in dollar volume transactions is increasing faster than MasterCard's capital expenditures, the stock buyback is taking 3-5% of the shares off the market per year, and the dividend payout ratio is in the early stages of double-digit growth as the current payout ratio is still only 14% of current profits. Based on those facts, you can draw your own conclusions if you prize rapidity of income growth over the current level of income generated.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.