It's Time To Embrace Dividend Growth

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Includes: ABBV, CSCO, WYN
by: Casey Hoerth

Summary

Many of the traditionally high-yielding names and industries have appreciated considerably over the last six months.

I believe that dividend-growth names right now offer a better value.

This article highlights three dividend growth names, each of which I have recently recommended, as examples to illustrate my point.

On the debate between dividend growth and dividend yield, I'm a bit of an agnostic. I like both approaches and will go with either one when the valuation is right. For the past couple years that has meant going for the higher-yielders: Names such as AT&T (NYSE:T), Realty Income (NYSE:O) and Ventas (NYSE:VTR), which each yielded over 5% and typically grew dividends by the single digits.

Click to enlarge AT&T, Realty Income and Ventas Inc. Courtesy of Google Finance.

Well, those 'high-yielders' have appreciated significantly. These three certainly aren't the only names worth following, but they do represent a good cross-section of high-yielding dividend stocks.

Meanwhile, there are a good number of 'dividend growth' names that aren't expensive at all. These are typically stocks that yield around 3% or less, and grow dividends by high single-digits or low double-digits. Again, have a look at three of the stocks I follow which fall into the latter category.

Click to enlarge

Chart of Cisco Systems (NASDAQ:CSCO), AbbVie (NYSE:ABBV) and Wyndham Worldwide (NYSE:WYN).

Just from looking at this chart we see that these dividend growth names haven't done much over the last six months, even though the broader market has gone up significantly. Given the market's overall direction, there certainly are many dividend growers that have appreciated by a lot. As with almost every sector, industry or group right now, investors have to pick carefully, but I think these three are good examples of the value remaining with 'dividend growth' names.

Pharmaceutical AbbVie, for example, sits at just 13.2 times trailing earnings versus a ten-year average valuation of 15.1 times (according to data from FAST Graphs); a discount of 12.5%. While AbbVie is young as an independent company, I believe it has a long runway of dividend growth ahead of it. This maker of drugs such as Humira and Imbruvica expects double-digit earnings and revenue growth through 2020, and I fully expect the dividend to follow that trajectory because the dividend is only 70% of free cash flow.

In 2015 AbbVie raised its dividend 20%. I recommended AbbVie on February 5th and continue to do so. Growth will be propelled not only by Humira, but also by the Pharmacyclics acquisition and by Imbruvica, the Hep C drug newly put on the market.

I recommended hotel owner Wyndham Worldwide back on March 23rd. Wyndham yields just 2.7%, but management increased the dividend by over 20% each year since 2010, and there is still room to grow.

Last year Wyndham generated $769 million of free cash flow, but paid just $202 million in dividends. Management is looking for hotel acquisitions, but said it would distribute cash to shareholders if the right deals did not materialize.

Without getting too deep into this diversified hotel owner, Wyndham expects 7%-9% constant-currency EBITDA growth, and I suspect dividend growth will be double that. Wyndham sits at 14.4 times trailing earnings and has averaged 15.1 times earnings over the last ten years. That's a discount of 4.5%.

As for Cisco Systems, it has been undervalued for awhile, but its dividend growth provides for some very strong upward momentum. Management of this networking giant expects 4%-6% revenue growth over the long-term, but like the other two names, Cisco's dividend growth is going to well exceed earnings growth.

Last quarter the dividend was only 40% of free cash flow, and the company has $38.5 billion of net cash sitting in the bank! That means the dividend can only go higher, and I suspect that it will. Already this year Cisco raised its dividend by 24%. All that cash needs to go somewhere, and it will end up going into shareholders' pockets one way or another.

Cisco currently trades at 12.3 times earnings, and has averaged 14.4 times earnings over the last ten years. That comes out to a discount of 14.6%. I believe that Cisco in particular has a good bit of upside.

Conclusion

This article doesn't mean to argue that dividend growth names as a whole asset class can be bought at the moment. I'm more of the opinion that things are generally expensive. However, the better income values today can be found in dividend growth stocks. I believe these three represent a very good starting point. I'm long all three, and intend to continue accumulating for now when I can.

Disclosure: I am/we are long WYN, VTR, CSCO, ABBV.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.