Screening for the best Dividend Growth Stocks is both an art and a science.
The approach in this article requires companies to exhibit strong business growth if the current dividend yield is unsatisfactory.
I present you with a list of 48 Dividend Growth Stocks, picked out from the 423 companies in the S&P 500 which pay out dividends.
I believe that, at some point, every investor has asked himself whether stock picking is more of an art or a science. This question recently became more relevant for me. As I developed the Stock Relative Scoring System (SRSS), about which you can find more information here, I was reminded, by the very process I had designed, that the real secret sauce lies in the ability to meaningfully combine the required thresholds for different parameters. On a somewhat higher level, these combinations can be created by setting thresholds on scores which I have developed, such as Value, Growth, Profitability and Quality Score, etc. I even found it beneficial to set a combined minimum threshold for a pair of scores which complement each other. The quick pick list presented in this article would not have been possible without one such combination.
The purpose of this whole half-artistic, half-scientific process is to refine the information contained in the main score of the selected strategy. If you invest in growth stocks, you want to avoid overpaying for growth. If you are a value investor, you want to avoid value traps. And if you are a dividend growth investor, there are a number of factors you need to pay attention to:
- Is the current dividend level sustainable, considering the company's income and cash flow?
- Is the company itself growing? This is the requirement without which long-term dividend growth is virtually impossible.
- Is the current dividend or shareholder yield so low, that despite dividend growth it is not realistic to expect your investment to return a meaningful profit in the next 5, 10, or even 20 years?
Applying exactly the same criteria that I used to screen for attractive Dividend Growth stocks in the previous article yielded unsatisfactory results when applied to the 423 dividend paying companies in the S&P 500. Some companies, which found themselves close to the top of the list, are growing their revenues and income too slowly to be confidently included in a Dividend Growth portfolio. After a considerable refinement process, I created the following criteria for stocks to be included in the Best Dividend Growth from the S&P 500 selection. Keep in mind that all scores are relative, meaning they represent the position of the selected stock within the defined universe of stocks. The same stock will have a different Growth Score, for example, if it is measured against all listed companies in the USA, or against companies in the S&P 500.
- Growth Score has to be 40 or higher.
American Water Works Company (AWK) has a Growth Score of 40. With it, their net income from continuing operations grew at 5.9% (OTCPK:CAGR) over the past three years, while revenue grew at 2.9% CAGR. Along with their other growth numbers, this slow and steady growth qualifies as "good enough" to be able to sustain dividend growth. Therefore, I consider all companies with higher growth rates as fit for selection.
2. The sum of Growth Score and either Dividend Yield or Shareholder Yield Score has to be above 100.
This is the combination that I hinted at in the beginning of this piece, and it replaces the requirement from the last article, which demanded that all selected stocks qualify in the top 30% in at least one of following scores: Value, Dividend Yield or Shareholder Yield. The logic behind the new criterion is simple. Dividend investors expect yield. If you invest in a Dividend Growth stock, you expect the yield to grow and make your investment ever more profitable down the road. Dividend growth is supported by the underlying business growth. By demanding the minimum sum of Growth and Yield scores of 100 I am essentially saying: if the company grows at below average rates, for Dividend Growth investors it should make up for it with an already above-average yield. If the yield is below average, I want to see the underlying business growing at above-average rates, to ensure a strong long-term increase in dividends, which will raise the yield.
3. Dividend Safety Score has to be 40 or higher.
This seems a somewhat laxer requirement than I set for Dividend Safety in the previous article, when I demanded a score of 50 or higher. I will remind you again that all scores are relative. The average company in the S&P 500 is definitely an entity with more stability than an average listed company on the broader market. For example, Marathon Oil Corporation has a dividend payout ratio of 18.3% and a dividend to FCF ratio of 57%, which nets the company a Dividend Safety Score of 42.1. I would say this is good enough (at least for a "quick picks" list) and that there is no need to set a stricter threshold.
4. Main Drivers Score (Value, Growth, Profitability and Quality) has to be 60 or higher.
I only want companies, which I would rate "Attractive" or higher, even if dividends were disregarded, to be included in the list. If I try to translate the numbers into language, this score means that the company has to have attractive growth rates, be attractively valued and offer attractive return rates with attractive margins. If the firm is found lacking in any of these criteria, it has to make up for it in one of the other two. For example, if the Valuation Grade is only "Neutral", then the company either has to grow at "Very Attractive" rates, or its rates of return and margins need to be "Very Attractive."
5. Finally, this list introduces Dividend per Share Growth Score as distinct from Dividend Growth Score.
Both of these metrics include some common parameters as input factors, such as the number of consecutive years of higher dividends. However, the DPS Growth Score does not consider the total amount of money paid out by the company as dividends to common shareholders, while the Dividend Growth Score is broader – it includes both dividend per share and total dividends to common paid. If you notice a wide gap between the scores, with the broad Dividend Growth Score lagging significantly behind the DPS Growth score, this indicates that the company has been pursuing an aggressive stock buyback program. What you do with that information is up to you, but I would be inclined to conclude that, with DPS growth rates being equal (between a pair of hypothetical companies), it is preferable to see that growth underpinned by an increasing total dividend payout sum, rather than a decreasing one.
The following list of Attractive Dividend Growth Stocks from the S&P 500 is sorted by their DPS Growth Score, with the cutoff score set at 75. To avoid letting companies which heavily depend on stock buybacks to prop up their dividend growth, I have set the broad Dividend Growth cutoff score at 50.
Some of the data used to build this list is sourced from the monthly U.S. Dividend Champions list, curtesy of my fellow Seeking Alpha contributor, Justin Law, whose articles every dividend investor should check out. You can do so here.
With all that in mind, I present you with the comprehensive list of all 48 stocks, which qualify under the listed criteria. As this is a "quick pick" list, readers are reminded that they need to do more research before committing a substantial amount of capital into any of the following stocks.
(Download the table in high resolution here: Dividend_scores_new.png.)
For a quicker way to determine where the strengths and weaknesses of each of the stocks lie, here is a color-coded representation of the grades awarded to the individual scores.
(Download the table in high resolution here: Dividend_grades_new.png.)
As usual, let us now take a closer look at the top 10.
Cintas Corporation (CTAS)
Cintas receives very little love on Seeking Alpha, with "bearish" or "very bearish" ratings assigned to the stock in five out of the last six articles published about it. Still, the stock has returned 54.8% in capital gains over the past year and the main question seems to be if it is now overvalued. This, indeed, shows in SRSS, where Cintas' Value Score is 33.4, and it has a dividend yield of 0.87%.
What places this company at the top of this list are the superior DPS Growth Score, Dividend Safety Score, Growth Score and Profitability and Quality Score of 100, 99, 95 and 88.6, respectively. The company has been raising its dividend for 37 consecutive years, and the increase has been speeding up over the past decade – dividend per share CAGR for the past 10, 5 and 3 years was 18.4%, 21.6% and 25%. CTAS net income has grown at 21.2% CAGR over the past five years, margins are healthy and steadily improving. Same goes for the return measures, ROA, ROE and ROIC which stand at 12.1%, 30% and 15.6%.
There is definitely a place for Cintas in investors' dividend growth portfolios, it is just a matter of a reasonable entry price. Further research is strongly recommended.
Lowe's Companies, Inc. (LOW)
This is a true Dividend King, a company which has relentlessly raised their dividend for 57 consecutive years. DPS growth has been steady over the past decade, with a CAGR of 19.4%. With the Value Score of 56.6 the stock seems to be relatively fairly priced, and their Profitability and Quality Score of 73.4 indicates a solid business model. LOW's weak spot is the Growth Score of 52.1. While Lowe's revenue grew at 6% and 6.5% CAGR over the past five and three years, their net income stagnated over the last five-year period and even decreased, at 3.1% CAGR, over the last three years. This is beginning to strain the company's aggressive dynamics of dividend increases, with the dividend to FCF ratio reaching 70.3%.
Further research should focus on Lowe's potential to reinvigorate their growth.
The TJX Companies, Inc. (TJX)
TJX is set to become a Dividend Aristocrat in two years. This retailer has been raising its dividends at an ever-increasing speed over the last decade. Dividend per share CAGR for the last three years was 22.9%. With a dividend payout ratio of 33.1% and dividend to FCF ratio of 46.2%, TJX payouts to shareholders are very safe. Both dividend and shareholder yields, however, are below average, with the forward dividend yield at 1.5%. I would not see that as an issue at all, if the company's Growth Score was higher, but with Growth scoring 63 points and Shareholder Yield at 38.1 points, TJX barely satisfies the second requirement listed – a sum of at least 100 for combined Growth and any of the Yield Scores.
A potential investment in TJX should be viewed as a very long-term one.
A. O. Smith Corporation (AOS)
I've already written briefly about AOS in my previous article, where it was featured at the top of the list. To briefly reiterate, AOS has a fast-growing dividend, low payout ratios and solid margins. Yet the growth shows signs of slowing down, and the company is extremely unloved by the market. I would recommend further research to avoid catching a falling knife.
MarketAxess Holdings Inc. (MKTX)
MarketAxess Holdings is an excellent company in pretty much all of the relevant metrics. Because this is so obvious, the stock appreciated 59.1% over the past year and now seems overpriced, with the Value Score at 13.9 and a negligible dividend yield of 0.7%.
Before additional research, my suggestion would be to watch this one closely and consider buying once there is a steep correction.
Disregard the Dividend Safety Score on this one, it is only low because FCF data for the last year was unavailable as of the time of writing.
Ross Stores, Inc. (ROST)
With 25 years of consecutive dividend growth, ROST is a fresh Dividend Aristocrat. The DPS Growth Score of 99.1 positions the company in sixth place on the list, and the low payout ratios of 22% and 24% for dividend payout and dividend to FCF make the dividend very safe. The downside here is that the dividend yield is very low, at 0.87%. Due to share buybacks, shareholder yield is slightly better at 3.8%, which is barely enough to result in a sum of Growth Score and Shareholder Yield Score above 100, to pass the second requirement for inclusion on this list. On the plus side, ROST revenue and operating and net income growth rates are healthy, and the return rates of ROA, ROE and ROIC are very strong at 21%, 50.9% and 30.1%.
Investment in Ross Stores will require patience before it begins to return a substantial dividend income. Still, it looks like a good candidate for a long-term investment, perhaps for a retirement portfolio.
Parker-Hannifin Corporation (PH)
With 63 years of increasing dividends, Parker-Hannifin is a long-established Dividend King. The stock rallied between August and December last year, which pushed the yield down to its current level of 1.7%. Since PH growth and profitability parameters are solid, but not outstanding, I would probably advise waiting for a correction before possibly investing.
Automatic Data Processing, Inc. (ADP)
Automatic Data Processing is one of my favorites among the top 10 of this list. Here we have 44 years of consecutive dividend growth, with dividend per share CAGR speeding up to 14.2% for the past three years. That is not the fastest growth, but on the plus side there is the 2% dividend yield which is just slightly below average. It should not take too long for the dividend to become attractive, with the underlying business scoring 83.4 in the Growth Score, and 94.7 in the Profitability and Quality Score. The company's margins are stable, strong and in an uptrend. ROIC and ROE are both very high, at 30.1% and 48.6%, respectively.
ADP should be among the prime candidates for a long-term dividend growth portfolio.
T. Rowe Price Group, Inc. (TROW)
The fact that a company such as the T. Rowe Price Group finds itself only in ninth position on this list, serves as a reminder that every list is imperfect. TROW probably deserves the top spot in the list. The stock rallied 50.3% over the past year, and still doesn't seem to be too expensive, with a Value Score of 84.3. The dividend yield of 2.2% is average, but when combined with 33 years of consecutive dividend growth, which has reached 12.1% CAGR over the past three years, it looks pretty attractive. The current level of dividends seems safe, with a Dividend Safety Score of 74.8. The continued growth of the company seems all but assured, with the Growth Score at 80.5 and the Profitability and Quality Score at 86.
Further research on TROW should focus on a simple question: is it too good to be true?
Visa Inc. (V)
V stock has kept marching forward ever since it was listed, almost 12 years ago. During that entire period, there was only one price correction worth mentioning, in December 2018, when the stock dipped 17%. Visa Inc. is an outstanding company, with the Growth Score at 98.8 and the Profitability and Quality Score at 99.2. While the annual dividend per share has been growing at over 20% CAGR, Visa only pays out a negligible amount of its earnings as dividends – both dividend to FCF and dividend payout ratios stand at 0.8%. Considering their track record and continuing fast growth, a stock price correction seems unlikely unless bears take the helm of the entire stock market.
I would consider adding Visa for a retirement portfolio.
Values in this article reflect market prices as at the market close on February 7th, 2020.
The order in which companies are listed in this article is not necessarily the order in which I would recommend them. Ultimately, no matter how many criteria and thresholds are set, the list is sorted by one parameter, which here was Dividend per Share Growth Score. Therefore, even slightly faster dividend growth positions a stock higher than another, which may, or may not, represent a superior investment in a number of different categories.
Scores and grades published in this article, inside the two data tables, enable dividend investors to quickly determine where the strengths and weaknesses of each of the companies lie and what they should focus their research on.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.