The word Growth is the central word in the phrase Dividend Growth Investing, yet "DGI" is often looked at as a strategy focusing on low growth, "widow and orphan" type of investments. This mischaracterization is unfortunate, because it can cause younger investors to bypass the strategy in favor of more exciting opportunities.
I realize that those boring, higher yielding, low growth companies are popular in many of the public portfolios covered here on Seeking Alpha, but there are also plenty of other higher growth companies that fit under the "DGI" umbrella as well.
Last week I highlighted the six companies I considered the best growth stocks available from the Dividend Champions List. Today I will take a look at the Dividend Contenders, which is a list of the 239 companies listed on U.S. exchanges that have raised their annual dividends for the last 10-24 years.
To determine which companies would be considered for this article, I screened the Contenders and highlighted all those that have provided double-digit dividend growth with the most recent raise, as well as over the 3YR, 5YR, and 10YR time frames. I then reviewed those companies on F.A.S.T. Graphs to look at their earnings history, and tossed out companies that had single-digit EPS growth and those that had high fluctuations in earnings. Finally, I checked analysts' growth estimates on F.A.S.T. Graphs and Yahoo Finance to find those that are projected to grow at a 10%+ rate going forward.
The end result is ten companies covering a variety of sectors that have shown a long history of consistent and repeatable earnings growth that has translated into strong dividend growth and impressive capital gains.
The list is represented by a nice mix of companies, with three coming from the consumer discretionary sector, two companies each from the industrial, consumer staple and health care sectors, and a lone company from the information tech sector.
As one might expect, the dividend yields are fairly low, as every stock is currently yielding less than 2%. However, these stocks weren't selected for income, they were selected for growth and capital gains, and as we'll see below, they have performed quite well in that respect.
A.O. Smith Corp. (NYSE:AOS) is a manufacturer of residential and commercial water heaters, boilers and water treatment products headquartered in Milwaukee, Wisconsin. The company has a 23 year streak of dividend growth and has produced a 13.5% dividend growth rate over the last decade.
A.O. Smith has limited information available on F.A.S.T. Graphs, presumably due to the merger transaction completed with Smith Holdings in early 2009. However, in the limited time-frame that is available you can see the company has done quite well, as earnings have grown at a 21% clip since 2009.
The combination of strong growth and an expansion of the PE ratio from 16 to nearly 27 has produced some remarkable gains for investors. Those who have held since the end of 2009 have seen nearly 33% annual gains, good enough to turn a $10,000 investment into $67,820 today
AOS is trading at 26.8 times expected 2016 earnings, which is more than 25% higher than its normal PE of 21. Looking at recent history shows that share price tends to bounce off the trend line from time to time, so it may be wise to wait for a pullback for a new purchase. My buy target would be around the $76 level, which is a 21 PE on 2016 earnings.
AmerisourceBergen Corp. (NYSE:ABC) is a pharmaceutical services company that sources and distributes products to healthcare providers, pharmaceutical and biotech manufacturers, and drug patients in the United States and abroad. The company has an 11 year streak of increases and has produced a 44.1% growth rate over the last decade.
AmerisourceBergen has also produced strong earnings growth of 16.7% over the last 20 years, although that has slowed a bit of late, and analysts are projecting 10-12% growth going forward. The slowing growth, along with general market concerns regarding the pharmaceutical sector, has caused shares to sell off, and it now appears to be trading below fair value.
The company has produced annualized returns of 14.9%, more than double the rate of the S&P, turning a $10,000 investment into over $160,000. It also produced more income than the S&P due to its high growth rate, despite having an initial yield of just 0.5%.
The stock has sold off in the last year and shares are currently trading at just 15 times expected 2016 earnings of $5.55, which is below my fair value PE target of 16. This appears to be a decent entry point for the stock.
Costco Wholesale Corporation (NASDAQ:COST) is a retailer offering branded and private-label products and consumer services through its membership warehouses and online. The company was founded in 1976 and is headquartered in Issaquah, Washington. It has a 13 year streak of dividend increases and has produced a 13.3% growth rate over the last decade.
Costco doesn't have quite the growth rate of some others on the list, but it does consistently churn out 10%+ gains. This consistency has been rewarded by the market, as the stock has traded with a normal PE in the 23-25 range over pretty much every time frame over the last 20 years.
This has translated to 15% annualized returns, again more than double those seen by the S&P.
Costco is currently trading at 25.6 times expected 2017 earnings of $5.95, putting it above an already high "normal" valuation. However, the stock hasn't traded below a 24 PE since 2012, so if you're waiting for a deal on the shares, you may be waiting for a while. I'm not willing to pay 25.6 times forward earnings for a 1.2% yield and 10% growth, but at $140 I'd start getting interested.
CVS Health Corporation (NYSE:CVS) is an integrated health services company that operates pharmacy & retail stores, pharmacy benefit services, and clinical services. The company was founded in 1963 and is headquartered in Woonsocket, Rhode Island. CVS has a 13 year streak of dividend increases and has produced a 25.4% dividend growth rate over the last decade.
CVS has grown earnings at a 12.9% rate over the last 20 years, 13.6% over the last 5 and analysts expect 12.5% growth going forward. Dividend growth has outpaced earnings growth and this will likely continue the next few years as management has guided for a 35% payout ratio by 2018, compared to a current 29%.
CVS has produced 12.1% annualized returns compared with 7.2% from the S&P.
As stated in my recent coverage of the stock, I continue to believe that CVS is undervalued at current prices. It has sold off along with other pharmacy benefits managers "PBMs", resulting in a current PE of 15.5 and forward PE of 13.8 compared to a fair value target of 16.5. This means that shares appear to be trading at a 5-15% discount to fair value.
FactSet Research Systems Inc. (NYSE:FDS) is a provider of financial information and analytical applications to the investment community in the United States, Europe, and the Asia Pacific. The company was founded in 1978 and is headquartered in Norwalk, Connecticut. It has an 18 year streak of dividend increases and has produced a 23.9% growth rate over the last decade.
FactSet has one of the higher long-term growth rates of the companies on this list, producing 19.6% annual growth over the last 20 years. However, this growth rate has slowed over the years to 14.1% over the last decade and 11.6% over the last 5, and analysts are expecting it slow further to 10% growth going forward.
As you'd expect, this tremendous growth has provided excellent returns, turning a $10,000 investment into $425,000 over the last 20 years, which is nearly 11X the total returns provided by the S&P.
The stock has generally traded in a fair value range of 24-26 times earnings, and with a current PE of nearly 28, it appears to be overvalued at current prices. Also, when taking into account a slowing growth rate, I would need a discount to the fair value range for my buy target. $140 would be a level where I'd start showing interest in a position.
Nike, Inc. (NYSE:NKE) is a footwear, apparel, and equipment company that sells its products worldwide. The company was founded in 1964 and headquartered in Beaverton, Oregon. The company has a 14 year streak of dividend growth and has increased its payout at a 15.5% annual rate over the last decade.
Nike is another excellent example of a secular growth stock, having produced a 14.9% annual growth rate without a single year of negative growth going back to 1999. This is likely to continue, as analysts are forecasting 14-15% EPS going forward as well.
Nike has thoroughly beaten the market, returning 13.6% compared with 5.3% from the S&P. Unlike some of the other companies, Nike's dividend growth has generally matched EPS growth as it has maintained a ~30% payout ratio in recent years.
Looking at valuation on the long-term FAST Graph, it appears that Nike is overvalued compared to a historical normal PE of around 21. Yes, the normal PE has expanded to 24 when looking at the 5 year time frame, however I don't see any rational reason for the higher multiple considering the growth rate has remained the same at around 14%. With the stock currently trading at 23X expected 2017 earnings, I would need another 10% pullback to the $50 level to get interested in opening a position.
Rollins Inc. (NYSE:ROL) is a pest control company serving more than 2 million customers in the U.S. and international markets. The company was founded in 1948 and is headquartered in Atlanta, Georgia. Rollins has a 14 year streak of dividend growth and has increased the payout at a 18.4% annual rate over the last decade.
Rollins has one of the prettiest F.A.S.T. Graphs you will ever see as it has churned out 19.8% annual growth over the last 15 years. This has slowed a bit in recent years, to more the 10-15% range, and analysts are expecting 9-13% growth going forward.
For a company that has completely flown under my radar, I was surprised at how well the company has performed over the years. Rollins has returned 17.5% annually over the last 15 years compared with just 3.5% from the S&P. It also produced three times the income of the S&P despite beginning with a yield of just 1%, demonstrating the power of compounding with a high dividend growth rate.
Rollins is currently trading at nearly 39X expected 2016 and 34X 2017 estimates, putting it well above a normal PE of around 30. As with Nike, the current growth rate is at or below historical levels, so I don't see where a premium is justified. I would look at the $22.50 level as a potential buy target for a new position.
Ross Stores Inc. (NASDAQ:ROST) is a discount apparel and home fashion retailer that operates under the Ross Dress For Less and dd's DISCOUNTS names. The company was founded in 1982 and is headquartered in Dublin, California. Ross Stores has a 22 year streak of dividend increases and has raised the payout at a 24.5% rate over the last decade.
ROST has been a tremendous grower, putting up 19.5% annualized EPS growth over the last 20 years, although this has slowed to 14.8% over the last 5. Looking ahead, analysts are expecting 11.5% growth going forward.
Long-term shareholders in this company have to be smiling, as it's rewarded them with 23.7% annual returns, turning a $10k investment into $725k in twenty years. Remarkably, despite an initial yield of just 0.5%, it nearly quadrupled the income output of the S&P as well.
Ross Stores has generally traded at 16-18 times earnings, so with a current PE of 23.4 and forward PE of 21.1, it appears to be 20-30% overvalued right now. I would be looking at the $50 level as a point to potentially add to my position.
Stryker Corporation (NYSE:SYK) is a medical technology company that operates in three segments: Orthopaedics, Medical & Surgical, and Neurotechnology & Spine. The company was founded in 1941 and is headquartered in Kalamazoo, Michigan. Stryker has a 23 year streak of dividend growth and has increased the dividend at a 31.4% annualized rate over the last decade.
Stryker has been another consistent performer through the years, putting up a 15.5% growth rate over the last 15. It's done so without a single year of negative growth, and double-digit growth in all but three. Looking ahead, analysts project 10% growth over the next five years.
Stryker has had outsized dividend growth over time, as the payout ratio has grown from <10% to the current 30% level. I expect that dividend growth will more closely match earnings growth going forward.
Stryker is currently trading for about 20 times 2016 earnings, which seems cheap when compared with the 15YR normal PE of 25.3 seen above. However, looking at the most recent 5YR period, you can see that the market has been willing to pay just 16.4X earnings, presumably due to the slower growth rate.
With earnings growth forecasted at 10% going forward, I think the lower PE is justified. My buy target would be around the $105 level, which is a 16.5 PE on 2017 EPS estimates and a 18 PE on 2016 earnings.
The TJX Companies, Inc. (NYSE:TJX) is an off-price apparel and home fashion retailer in the U.S. and abroad. It operates stores under the T.J. Maxx, Marshalls, and other brand names, with a total of 3,675 store in 9 countries. The company was founded in 1956 and is headquartered in Framingham, Massachusetts.
TJX has a 20 year streak of dividend increases and has grown the payout at a 21.7% rate over the last decade. The company has been quite impressive on the earning's front as well, putting up 14.8% annual growth going back to 1999.
This strong growth has resulted in 17.1% annualized returns compared to 5.6% returns from the S&P. TJX also produced more than twice the cumulative income than the market despite having an initial yield of just 0.7%.
Shares are currently trading for 21.5 times 2017 earnings, which is a 20% premium to a historical normal PE of 17.5. With earnings growth of 10% forecast compared against a 10YR growth rate of 15.9%, I don't feel this premium is justified. I would be looking at the $61 level as my buy target.
These companies have produced some outstanding growth over the last two decades, and all are expected to continue growing at double-digit rates going forward. This high growth led to capital gains that outpaced the market, which is what one would expect. However, I was pleasantly surprised at how much they outperformed the market in regards to dividend income as well. This was despite many of them yielding less that 1% at time of purchase.
This reiterates my point that investors need to look beyond yield when choosing investments, as earnings are the driver for long-term gains. Certainly there are instances where current yield may be needed for income. However, for younger investors or those with a long-term approach, putting income before growth can result in missing out on a bigger next egg down the road.
Looking at valuations it appears the AmerisourceBergen and CVS Health, and to a lesser extent Costco and Nike, offer the best bang for the buck at current prices. The others are all worth watching as well, but will need to correct further in price to get me interested in buying.
I hope this list provides some ideas for investors looking for some "growthier" options for their portfolios. I plan to tackle the Dividend Challengers List next, and hope to identify companies with a shorter dividend history that are set up to produce double-digit growth going forward.
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Disclosure: I am/we are long ABC, CVS, ROST.
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.
Additional disclosure: I am a Civil Engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.