3 Double Digit Dividend Growth Companies On My Radar

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Includes: CMI, QCOM, WFC
by: The Dividend Guy

Summary

In a higher priced market like this one, you might want to focus on strong dividend growth companies. This is how you get paid to wait for the next bubble.

I’ve selected 3 companies showing double digit dividend growth for the past five years while they show strong profile to keep increasing at this rate.

For dividend growth investors, there isn’t really bull or bear markets. There are only strong companies paying increasing dividend year after year.

My analysis has been made considering each company business model, dividend growth perspective and investment thesis to enter in a position now.

The S&P 500 total return over the past five years is currently showing +72%. While investors just benefited from a very strong bull market, major indexes have been going up and down and provided virtually no value since August 2015. Since the average earnings have decreased over the past 12 months, we now face a stock market trading at a relatively high price.

Investors are now imprisoned by a dilemma with their new money: should they invest in a fully valued (some will argue it's overvalued) market or should they wait until the next bubble crash? I always tend to prefer to invest my money instead of waiting on the sidelines. Considering we are evolving in a highly volatile market post 2008, I find there are so many reasons each year to not invest in the stock market if I concentrate on global economic news. At the same time, if I had been waiting on the sideline since 2009 for the next bubble to crash, I would have not only miss one of the greatest bull markets of recent financial history, I would have also missed out on a considerable amount of dividend income.

For a dividend growth investor, there isn't really bull or bear markets. There are only strong companies paying increasing dividend year after year. If you invest your money in the three companies mentioned in this article, chances are you will enjoy generous dividend income payments and you won't mind what the market does.

Wells Fargo (NYSE:WFC)

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Source Ycharts

Business Model

Wells Fargo is a company offering financial services. It operates through 3 different segments: community banking, wholesale banking & wealth as well as brokerage & retirement. Wells Fargo is part of the famous Warren Buffett Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) portfolio. WFC is one of the first banks to climb out of the 2008 financial meltdown.

Dividend Growth Perspective

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Source: Ycharts

After the 2008 meltdown, all US banks were forced to maintain a very strict payout ratio. While this could limit the company's dividend growth, WFC managed to show a 49.13% dividend growth over the past 5 years (CAGR). Now… don't get too excited, the company has just gotten back to its pre-2008 level within the first 4 years of increase. However, WFC is still showing a payout ratio under 40% and a cash payout ratio under 50%. As we expect Wells Fargo to keep growing its revenues and earnings in the upcoming years, the company will continue to be generous with its shareholders.

Investment Thesis

Since it's a savings & loans business model, the company will also benefit from future rising interest rates. Higher interest rates leads to better spread between CODs and loans when it's time to pair them. A stronger economy will also direct more clients into the arms of banks. Since Wells Fargo is the largest deposit gatherer in major cities across the country, it will occupy a place of choice for new customers.

The company has focused on improving its cross-selling ability providing several products to their clients. This obviously improves the company's margins and also increases the switching cost for any client who wishes to leave. Just think of all the hassles you have to go through if you want to switch your bank accounts, loans, credit cards and investments. You will need a very good reason to quit your bank. Definitely, Wells Fargo meets my 7 investing principles and even goes above and beyond.

Valuation

For each company, I've looked at the past 10 years PE ratio to see how market valued the company in the past and I've also used the Dividend Discount Model as this is what I'm interested in as a dividend growth investor.

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Source Ycharts

As you can see, the bank hasn't benefit from a valuation hype in the past 2 years. It's more the opposite that is happening right now.

In order to determine the company's value with the Dividend Discount Model, I use a double stage dividend growth calculation enabling me to show a stronger rate for the first 10 years and a more conservative one for the years after:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.52

Enter Expected Dividend Growth Rate Years 1-10:

7.00%

Enter Expected Terminal Dividend Growth Rate:

6.00%

Enter Discount Rate:

9.00%

Click to enlarge

As you can see, the company trades at a 10% discount even with highly conservative assumptions:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix

Discount Rate (Horizontal)

Margin of Safety

8.00%

9.00%

10.00%

20% Premium

$105.42

$70.05

$52.38

10% Premium

$96.64

$64.21

$48.01

Intrinsic Value

$87.85

$58.37

$43.65

10% Discount

$79.07

$52.54

$39.28

20% Discount

$70.28

$46.70

$34.92

Click to enlarge

Source: Dividend Toolkit Calculation Spreadsheet

Qualcomm (NASDAQ:QCOM)

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Source Ycharts

Business Model

Qualcomm Inc develops digital communication technology called CDMA (Code Division Multiple Access), & owns intellectual property applicable to products that implement any version of CDMA including patents, patent applications & trade secrets. Qualcomm is a significant innovator of CDMA network technology, the backbone of all 3G networks. The company derived most of its income from the smartphone business selling chips for power and network connectivity. Essentially, phones are unable to connect to 3G networks without paying a royalty (about 3%-5% of the price of the handset) to the company.

Dividend Growth Perspective

As is the case for many other techno stocks, QCOM has reached some kind of maturity in its market and is able to distribute significant cash flow to its shareholders. The company now shows a dividend growth rate of 20.11% CAGR over the past 5 years:

Click to enlarge

Source Ycharts

What is even more interesting is that the company shows a payout ratio under 60% and a cash payout ratio under 50%. This leaves lots of room for additional growth for the upcoming years.

Investment Thesis

Its leadership position in 4G LTE chipsets and strong relationships with major smartphone makers establishes solid bases for an ever increasing cash flow. However, nothing is perfect in the mobile industry. QCOM is facing serious collection problems in China and is currently losing market share among the biggest smartphone players such as Samsung (OTC:SSNLF) and Apple (NASDAQ:AAPL). There are also regulations issues pointing ahead where some countries (like South Korea) are determining that the royalty should not be paid based on the smartphone's full price.

The company is well aware of these potential risks and this is why they have started a cost reduction plan to remain agile and keep their profitability. The company also expects to use its cash for M&A in order to diversify its product offering and keeps its edge on the market.

Finally, due to the increasing phenomenon of the internet of things (IOTG; how various devices connect to each other), I believe QCOM will continue to benefit from the growing usage of smartphones in the future.

Valuation

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Due to its recent difficulties in China, the company has lost some valuation multiplier for the market and the stock price has dropped significantly (roughly -25% over the past 12 months).

Since this company is evolving in the technology sector, I'll use a higher discount rate of 11% to make sure we consider all risks in my Dividend Discount Model calculation:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$2.12

Enter Expected Dividend Growth Rate Years 1-10:

8.00%

Enter Expected Terminal Dividend Growth Rate:

7.00%

Enter Discount Rate:

11.00%

Click to enlarge

You can see there is a small discount on QCOM even with a high discount rate:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix

Discount Rate (Horizontal)

Margin of Safety

10.00%

11.00%

12.00%

20% Premium

$98.55

$73.69

$58.79

10% Premium

$90.34

$67.55

$53.89

Intrinsic Value

$82.13

$61.41

$48.99

10% Discount

$73.92

$55.27

$44.09

20% Discount

$65.70

$49.13

$39.19

Click to enlarge

Source: Dividend Toolkit Calculation Spreadsheet

Cummins (NYSE:CMI)

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Source Ycharts

Business Model

Cummins Inc., a global power leader, is a corporation of complementary business units that design, manufacture, distribute and service diesel and natural gas engines and related technologies, including fuel systems, controls, air handling, filtration, emission solutions and electrical power generation systems.

The company is divided into 4 business segments:

Engine (42% of sales)

Distribution (26% of sales)

Power Generation (11% of sales)

Components (21% of sales)

It's key advantage is CMI expertise in the design of lower emission generating engines. This is how Cummins gained a lot of market share over the past decade. Thanks to the help of heavier regulations from the Environmental Protection Agency, CMI is working with its clients to meet these new requirements.

Dividend Growth Perspective

CMI has been more than generous with its shareholders over the past 5 years. In fact, the company shows a dividend growth rate of 32.03% CAGR. You can see how strong the dividend payment trend has been over the past 6 years:

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Source Ycharts

The company will not be able to maintain such strong trend, but it is definitely in a good position to keep increasing its payment year after year considering both payout and cash payout ratio around 50%.

Investment Thesis

An investment in CMI is based on its ability to protect its know-how in designing more eco-friendly engines. New markets are slowly but surely opening to Cummins due to this specific expertise. Europe in the upcoming years and later China & India will also improve their environmental rules with regards to emissions. They will then open the doors to company such as Cummins to benefit from their expertise. CMI has already created partnerships with important clients such as TATA in India.

It is very difficult for its competitors to catch up on 10 years of massive R&D investments to develop such technology. This is how Cummins should keep its competitive advantage for a while.

Valuation

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Source Ycharts

The stock value is down about 18% over the past 12 months, but has gone up by 18% in the past 6 months. This explains the variation in the PE ratio over on the graph above. We are getting closer to a full valuation, but it seems there is some room for improvement.

Using the Dividend Discount Model, I've selected a 10% discount rate along with a 8% dividend growth rate for the first 10 years and a lower rate of 6% afterwards:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$3.92

Enter Expected Dividend Growth Rate Years 1-10:

8.00%

Enter Expected Terminal Dividend Growth Rate:

6.00%

Enter Discount Rate:

10.00%

Click to enlarge

Here again, I come to the same conclusion, there is still a small improvement in its short term value potential:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$196.30

$146.34

$116.41

10% Premium

$179.95

$134.15

$106.71

Intrinsic Value

$163.59

$121.95

$97.01

10% Discount

$147.23

$109.76

$87.31

20% Discount

$130.87

$97.56

$77.61

Click to enlarge

Source: Dividend Toolkit Calculation Spreadsheet

The right time to buy Cummins was obviously at the beginning of the year.

Final Thoughts

If I had to pick 1 company out of these three, I would go with QCOM if I'm looking for both dividend and stock value growth (mind you, I think it's a riskier pick as well) and I would pick WFC to build a core portfolio.

Disclaimer: We own shares of WFC in our Dividend Stocks Rock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Disclosure: I am/we are long WFC.

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.