Top 10 Consumer Discretionary Stocks For Dividend Growth And Income

by: Eric Landis

Consumer discretionary stocks, especially those in the retail sector, have been hit hard in recent weeks.

The pullback has brought several companies back to fair valuation, although uncertainty remains in growth expectations going forward.

This article presents 25 of the best companies in the consumer discretionary sector, from which I select the top 10 stocks for dividend growth and income.

Series Overview

This is part six in a series of articles covering the top dividend growth stocks in various sectors of the stock market. For easy reference, here are the previous sectors that have been covered:

These articles have attempted to identify the best stocks in each sector for providing current and future income by focusing on companies with strong financials and a history of consistent and reliable earnings and dividend growth. With this series, I hope to present investment ideas for current and soon-to-be retirees as they look for income from their portfolios.

The Consumer Discretionary Watch List

In contrast to the consumer staples sector that was covered previously, the consumer discretionary sector is generally considered a more volatile landscape for investments. Consumer preferences for clothing and restaurants change more often than their tastes for toothpaste and toilet paper do, and discretionary spending is the first to go when tough economic times hit, making it more sensitive to recessions than some of the other sectors.

This isn't to say there aren't good investment opportunities in the sector. There are a handful of names with long track records of dividend growth, as the sector constitutes 114 of the 745 positions on David Fish's U.S. Dividend Champions List. With so many investment ideas to choose from, this has proven to be the most difficult sector thus far for me to reduce down to a 25 stock watch list.

There were plenty of interesting and attractive companies to choose from, and as with previous sectors, I focused this watch list on companies with investment grade credit ratings of BBB- or better. I also looked at the companies on F.A.S.T. Graphs to weed out companies with a volatile earnings history and those who cut dividend payouts during the 2008/2009 recession.

Here are the 25 that made the initial list, along with some general information and their current prices in relation to 52-week highs.

Company Ticker Sub Sector # Years Div. Inc. S&P Credit Rating Debt / Cap Market Cap (B$) 52-Week High 52-Week Low Share Price 11/27/15 % Below 52-Wk High
Brinker International, Inc. (NYSE:EAT) Restaurants 11 BBB- 110% $2.7 $63.40 $43.91 $46.11 -27.27%
Comcast Corporation (NASDAQ:CMCSA) Media 8 A- 44% $151.0 $64.99 $50.01 $61.59 -5.23%
Cracker Barrel Old Country Store, Inc. (NASDAQ:CBRL) Restaurants 13 N/A 43% $3.1 $162.33 $117.95 $128.99 -20.54%
Diageo plc (ADR) (NYSE:DEO) Alcoholic Beverages 6 A- 42% $72.8 $124.32 $100.59 $115.81 -6.85%
Gap Inc (NYSE:GPS) Retail - Clothing 11 BBB- 33% $11.1 $43.90 $24.70 $27.36 -37.68%
Genuine Parts Company (NYSE:GPC) Auto Parts 59 N/A 13% $13.7 $109.00 $78.76 $90.88 -16.62%
Hasbro, Inc. (NASDAQ:HAS) Toys/Recreation 12 BBB 47% $9.4 $84.42 $51.42 $75.37 -10.72%
Home Depot Inc (NYSE:HD) Retail - Home Impr. 6 A 58% $170.8 $135.47 $92.17 $134.75 -0.53%
Johnson Controls Inc (NYSE:JCI) Auto Parts 5 BBB+ 33% $29.6 $54.52 $38.48 $45.70 -16.18%
Leggett & Platt, Inc. (NYSE:LEG) Furniture/Bldg Prod. 44 BBB+ 47% $6.4 $51.28 $39.38 $47.16 -8.03%
Lowe's Companies, Inc. (NYSE:LOW) Retail - Home Impr. 53 A- 51% $71.6 $78.13 $62.91 $77.37 -0.97%
McDonald's Corporation (NYSE:MCD) Restaurants 39 A- 53% $104.9 $114.99 $87.50 $114.24 -0.65%
Meredith Corporation (NYSE:MDP) Publishing 22 N/A 42% $2.1 $57.22 $39.40 $47.01 -17.84%
Nike Inc (NYSE:NKE) Apparel 13 A- 8% $114.5 $135.30 $90.69 $134.33 -0.72%
Nordstrom, Inc. (NYSE:JWN) Retail - Clothing 6 A- 49% $10.8 $83.16 $50.43 $57.61 -30.72%
Polaris Industries Inc. (NYSE:PII) Recreation Vehicles 20 N/A 24% $6.9 $158.24 $102.12 $105.70 -33.20%
Ross Stores, Inc. (NASDAQ:ROST) Retail - Clothing 21 A- 14% $21.5 $56.68 $43.47 $52.66 -7.09%
Starbucks Corporation (NASDAQ:SBUX) Restaurants 6 A- 28% $92.3 $64.00 $39.22 $62.18 -2.84%
Target Corporation (NYSE:TGT) Retail - Drug Stores 48 A 44% $45.2 $85.81 $68.15 $73.43 -14.43%
Texas Roadhouse Inc (NASDAQ:TXRH) Restaurants 5 N/A 7% $2.5 $40.82 $31.55 $35.49 -13.06%
TJX Companies Inc (NYSE:TJX) Retail - Clothing 19 A+ 27% $48.1 $76.93 $63.53 $71.35 -7.25%
VF Corp (NYSE:VFC) Apparel 43 A 17% $27.9 $77.83 $61.17 $65.33 -16.06%
Wal-Mart Stores, Inc. (NYSE:WMT) Retail - Discount 42 AA 32% $192.0 $90.97 $56.30 $59.91 -34.14%
Wyndham Worldwide Corporation (NYSE:WYN) Lodging 6 BBB- 79% $8.9 $94.35 $69.77 $76.24 -19.19%
Yum! Brands, Inc. (NYSE:YUM) Restaurants 12 BBB 51% $31.5 $95.90 $66.35 $72.94 -23.94%

As you can see, some of the companies have been hit harder than others with the recent sell-off, as 7 of the 25 companies are currently more than 20% below 52-week highs, while others like McDonald's, Home Depot, Lowe's and Nike are trading near 52-week highs.

Historical and Current Numbers

First up is a look at the historical dividend growth rates for the companies, as well as a look at the expected 2015 earnings and corresponding P/E and dividend payout ratios for them. The data in the following tables was collected from various sources, including the aforementioned Dividend Champions List, Yahoo Finance, Seeking Alpha, F.A.S.T. Graphs, and investor relations web pages from the selected companies.

For the earnings estimates and "Fair Value" P/E columns, I put each of the companies through F.A.S.T. Graphs and also went to the analyst estimates page on Yahoo Finance. The estimated 2015 earnings and expected 5YR growth rates came from a blend of the numbers from the two sources. The "Fair Value" number was determined by looking at several different time frames to determine what kind of valuations each company normally trades at. A comparison was then made between the expected P/E based on 2015 analyst estimates and the "Fair Value" P/E to get a feel for the relative values for the different options.

Similar to previous sectors, there is a wide variety of yields and valuations present in the discretionary sector as current yields range from 0.89% to 3.89% and P/Es range from 11.4 to 32.9.

This wide variety of opportunities can make portfolio selections difficult to make, but we will attempt to do so in the next spreadsheet breakdown.

Income Projections

Now that we've analyzed the historical and current numbers, it is time to take a crack at projecting the future income possibilities from the list to determine what are the best prospects for income investors.

To do this, I have checked investor presentations and conference call transcripts from each company to search for guidance regarding targeted dividend payout ratios. If guidance wasn't provided, I looked at the historical payout ratios on F.A.S.T. Graphs to see if there is any long-term trend for the company. From this data I determined my projected dividend growth rates for each company, which was then used to forecast a 5YR Yield On Cost "YOC" with dividends being withdrawn as well as the 5YR YOC with dividends being reinvested.

Additionally, on the far right I've shown my projected 5YR total returns based on the expected reinvestment of dividends and targeted valuation levels from the "Fair Value" P/E number.

As you can see, there are a few companies that stand out as opportunities for both high income and total returns. Based on current prices and valuations and expected future growth rates, half of the companies on the list are expected to provide double-digit annual returns going forward.

Surprisingly, due to high current valuations, some of the higher growth stocks like Nike, Home Depot, and Ross Stores are not among them. Meanwhile, slower growers like Gap Stores and Target are projected for double-digit returns despite single-digit earnings growth.

That said, the purpose of this article is to find the best income opportunities, and those will be unveiled below.

The Top 10

Now that we've covered how these projections were derived, it's time to pick the final top 10 income stocks from the results. As I've done with previous lists, this one was also ranked primarily by looking at the estimated 5YR YOC, with secondary consideration given to the current dividend yield and projected income with dividends reinvested. I believe the 5YR YOC gives a better idea of income potential for a stock, as it takes into account both the current yield as well as the expected growth of the dividend.

A reminder that these projected income numbers are based on current share prices and growth projections and are subject to future movement as initial yields and growth estimates change.

Brinker International, Inc., a leading casual dining restaurant company with more than 1,600 restaurants located in 30 countries, is the owner of the Chili's Grill & Bar and Maggiano's Little Italy brands. The company is a Dividend Contender with an 11-year streak of dividend increases, during which it has produced an 18.8% growth rate over the last 5 years.

In addition to a strong dividend, the company has also conducted an aggressive share repurchase program, which has reduced shares outstanding by about 50% over the last decade. This steady decrease in the share count has helped it to produce an annualized EPS growth rate of 9.1% during that period.

The company has a fairly high debt load with a 110% debt/cap, but maintains an investment grade credit rating of BBB- from S&P. While this looks reasonable in the current operating environment, it could be a concern in the future should another recession arise.

With a blended P/E of 14.0, the stock looks like a good value at current prices, especially when considering analyst expectations of a 14%+ growth rate over the next 5 years. When combined with a current yield of nearly 2.8%, this makes it an attractive option for income growth.

Cracker Barrel Old Country Store, Inc. operates a restaurant & gift shop store concept in the United States. It was founded in 1969 and is headquartered in Lebanon, Tennessee. The company is a Dividend Contender with a 13-year streak of dividend increases, during which it has raised payouts at a 22.8% annualized rate over the last decade.

Cracker Barrel has been the target of activist investor Sardar Biglari, which has led the company to increase returns to shareholders. The company has targeted an impressive 60% payout ratio, and has also recently paid special dividends on top of the normal dividend. Due to the conservative nature of the store concept as well as high ownership of restaurants by the company, the company has been a tremendously consistent performer over the years, with just one year of negative earnings growth since 2001.

Shares are currently on the expensive side, trading at nearly 18 times expected 2015 earnings. However, due to the high payout ratio, the stock is still yielding over 3.4%. With an expected growth rate in the high-single digits, income investors should be rewarded with continued dividend growth at a similar rate in the years ahead.

Meredith Corporation is a diversified media company that operates local television stations, subscription magazines, and on-line websites. The company is a Dividend Contender with a 22-year streak of dividend increases, during which it has grown payouts at a 13.7% rate over the last decade.

I don't expect those types of growth rates to continue in the next few years as the payout ratio has climbed to nearly 60% of earnings. However, with an expected 5% dividend growth rate and the highest current yield on the watch list at nearly 4%, the stock is an attractive option for income investors.

With shares off 18% from 52-week highs, the stock is now trading slightly below "fair value." The combination of a high initial yield, attractive valuation, and reasonable growth estimates makes Meredith an intriguing investment opportunity for potential 10% annual total returns.

Johnson Controls Inc. is a global diversified technology and industrial company serving the building and automotive industries. The company is a Dividend Challenger with a 5-year streak of dividend increases after freezing the payout during the "Great Recession." The current growth streak may not be overly impressive, but the fact that the company has been paying consecutive dividends to shareholders since 1887 surely is.

The company has produced a double-digit track record of growth since the recession, and expectations are for that to continue going forward. With a payout ratio at just 30%, there seems to be ample cushion to maintain a strong dividend growth rate as well.

Shares appear to be attractively valued at just 11.9 times expected 2016 earnings. With a double-digit growth rate and a current yield of 2.5%, this looks like a nice entry point for investors.

The Gap, Inc. is an apparel retail company that operates under the Gap, Banana Republic, Old Navy, Athleta, and Intermix brand names. The company is a Dividend Contender with an 11-year streak of dividend increases, during which it has grown payouts at a 25.3% annualized rate over the last decade.

The stock has been hit extremely hard this year, as shares are now trading nearly 40% below 52-week highs. This has resulted in an attractive yield of 3.4%. The stock is not without risk, however, as it owns just a BBB- credit rating, and could see further weakness should the retail sector remain soft.

Concerns aside, the stock appears cheap at just 11.4 times expected 2015 earnings. This low valuation, coupled with an expected mid-single digit growth rate, could lead to double-digit total returns over the next 5 years in addition to its attractive income potential.

Target Corporation is a general merchandise retailer based in Minneapolis, Minnesota. The company is a Dividend Champion with an impressive 48-year streak of dividend increases. Even more remarkable than the streak alone, is the fact that company has managed to grow the payout at better than a 20% annualized rate over the last decade.

I expect this rate to slow considerably in the next few years as the payout ratio has now exceeded management's target of 40% of earnings. However, with a dividend yield of 3.1% and an expected growth rate of 6% going forward, income investors could still see attractive returns.

Shares are currently trading near "fair value" and this appears to be a reasonable entry point for new investors.

McDonald's Corporation operates and franchises restaurants in the United States and worldwide. The company is a Dividend Champion with a 39-year streak of dividend increases, during which it has grown the payout at a 19.6% annual rate over the last decade. This outsized growth has led to an increasing payout ratio, and the recent 4.7% increase to an annualized $3.56 is nearly 67% of expected 2016 earnings.

Due to the higher payout ratio, I expect future dividend growth to lag earnings growth going forward, and am projecting annual dividend growth of 5% over the next 5 years. However, with a decent current yield of 3.1%, this is still fairly attractive for income investors.

Valuation is a bit of a concern, as the company is currently trading for 23.5 times 2015 earnings and 21.5 times expected 2016 earnings. So, while the stock is fairly attractive for income potential, those searching moreso for capital gains may want to look elsewhere at this time.

V.F. Corporation designs, manufactures, markets, and distributes branded apparel, footwear and accessories in the U.S. and Europe. The company is a Dividend Champion with a 43-year streak of dividend growth, and has produced an impressive annual growth rate of 15.5% over the last decade. This trend was reinforced with V.F. Corp's recent announcement of another 15.6% to $0.37 per share, which produces a payout ratio of 41% based on expected 2016 earnings.

At 20.6 times 2015 earnings and more than 18 times 2016 estimates, shares are currently trading above fair value, and providing a resulting dividend yield of just 2.3%. However, with an excellent track record of double-digit growth and expectations for this to continue going forward, the company is worth a strong look on any pullback.

Polaris Industries Inc. is a recreational and utility vehicle manufacturer that produces snow mobiles, ATVs, motorcycles in the United States and abroad. Polaris is a Dividend Contender with a 20-year streak of increases, during which it has raised the dividend at a 15.4% rate over the last decade.

The company has been an impressive grower over the years, and with sales for the Indian Motorcycle accelerating, it appears to be on a trajectory for continued growth going forward.

With shares now trading for just 14.3 times 2015 earnings, the company is now at valuation levels not seen since 2010. I highlighted the company in a recent article, and feel it is an attractive option for both income and total return investors going forward.

Yum! Brands, Inc. operates quick service restaurants under the KFC, Taco Bell, and Pizza Hut brand names. The company is a Dividend Contender with a 12-year streak of growth, and has raised the dividend at a 14.3% annual rate over the last 5 years.

The company has had a few hiccups over the last couple years in its China operations, which has resulted in stagnating earnings growth. This has led to an increasing payout ratio, which has climbed to nearly 52% of expected 2016 earnings, which is above the high end of guidance. As a result, I expect dividend growth to slow in the next few years to a high-single digit rate.

With shares trading above "fair value" and expectations for growth slowing a bit going forward, Yum! isn't quite as attractive as some others on the list. However, the company has been a tremendous performer over the years, and I expect it to still produce some nice returns for long-term investors in the years ahead.

Summary & Conclusion

The consumer discretionary sector has proven to be the most difficult for me to analyze. With uncertainty hitting certain portions of the retail sector, there are several companies trading at what appear to be compelling valuations. However, should the economy take a turn for the worse, analyst estimates will certainly come down and these income projection would as well.

Meanwhile, high-flyers like Nike, Starbucks, and Home Depot are executing well and producing strong growth, but are trading at nose-bleed valuation levels. Even worse, their high valuations depress dividend yields and produce unappealing projections for income over the next five years.

In the end, whether due to valuation or uncertainty, there is risk involved with many of these companies, and investors would be wise to stick to quality with the laggards and be patient in waiting for better values from the leaders.

Happy Investing!

Disclosure: I am/we are long CBRL, MCD, PII, ROST, SBUX, TGT, WYN. 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.